What is a ‘Land Contract’ All About?

Written by Nailing x

October 1, 2017

Sellers have various avenues they can take to offer buyers incentives to purchase their homes, and one of them is through seller financing. Most home purchases are done with the assistance of financing in order to help make it feasible for buyers to claim title on a property, and sometimes buyers can turn to the seller themselves rather than the bank when it comes to obtaining financing for a home.

Land contracts are useful tools for sellers who may find themselves in a dip in the housing market. They’re also useful for buyers who may otherwise find it difficult to get approved for a traditional mortgage.

What is a Land Contract?

A land contract is a legal contract that’s used to buy many types of real estate and is a form of seller financing. Like a traditional mortgage, it allows buyers to finance a home purchase without having to pay all-cash. However, rather than the funds being held by a lender, they’re held by the seller – or owner – of the property that’s been sold. All regular monthly payments that would have otherwise been paid to the bank are instead paid to the seller until the purchase price has been fully paid back.

Both buyer and seller will sign a land contract that stipulates all of the terms and conditions of the sale, after which the title of the property is transferred to the buyer through a deed to convey title.

However, the buyer is essentially an ‘equitable title holder’, which means that although they have the right to full ownership of the property, they don’t yet have legal title, which is the actual ownership of the land. While both parties are bound to the land contract, the seller cannot sell the property to someone else in the meantime.

When the buyer makes the final payment and all terms of the land contract have been met, the deed will be filed appropriately and the buyer will be named the new owner.

If the buyer fails to make the required monthly payments to the seller or doesn’t fulfill the necessary duties as stated in the land contract, the seller may file what’s known as a ‘land contract forfeiture’. This essentially means that the buyer is actually forfeiting all the money that has already been paid to the seller in previous payments and will no longer have equitable title, and the seller will keep the property.

What Are the Advantages of a Land Contract?

A land contract can be beneficial for both buyer and seller. Obviously, buyers will benefit from this type of arrangement if they are unable to qualify for a conventional mortgage with a lender because of poor credit or unhealthy financial history. Making regular payments while under a land contract will give buyers an opportunity to improve their credit so that they will eventually be able to get approved for a conventional loan in the future.

For sellers, the advantage lies in the availability of receiving a passive income at an interest rate that’s often better than other types of investments. While sellers may not be receiving the full purchase price as they would if the buyer had taken out a traditional mortgage, they may be able to demand a higher purchase price and bigger down payment in exchange for the arrangement.

In addition, sellers are not required to adhere to any stringent requirements about the condition of the property that lenders usually enforce in order to protect their collateral. A land contract also makes it easier for sellers to find a buyer even when the market is in a downturn.

How Can Sellers Protect Themselves in a Land Contract?

Of course, there is a risk for sellers to who choose to sell their homes by land contract. That said, there are things that sellers can do to reduce the risk associated with an arrangement like this.

Pull the buyer’s credit report. This will tell you if the buyer has had any previous troubles defaulting on loans, has filed bankruptcy in the past, or has any other significant issues with their credit.

Check the buyer’s employment. Ask for an employment letter from the buyer’s current employer, and verify how long the buyer has been employed, whether they are considered a permanent full-time employee, and what their wages are.

Request a list of references. Speak with the buyer’s previous landlords to see if the buyer has been able to pay rent on time each month or if they were delinquent on their financial obligations.

Ask for a title insurance policy. Title searches will show if the buyer has ever had any liens or judgments filed against them.

Require a large down payment. The more money a buyer is able to come up with in one lump sum, the better the odds that they will be able to make good on their regular monthly payments.

Ask for a balloon payment. Even if the payments are amortized long-term, receiving a balloon payment periodically throughout the amortization period will permit the buyer to be able to either sell earlier to pay you back or refinance a home loan.

Require that the buyer take out a home insurance policy. The buyer should be responsible for the home while they have equitable title to it and are living in it. As such, make sure they take out a homeowner’s insurance policy so that you are protected should anything happen.

The Bottom Line

Land contracts aren’t exactly common, but they do have their place in certain situations, especially when sellers are looking to unload their homes in a market downturn and buyers are unable to secure a traditional mortgage. It’s important that both buyers and sellers weigh the pros and cons of a land contract before diving into one, which means a conversation with a lawyer and real estate professional is warranted before such a decision is made.

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