Land contracts are seller-financed alternatives to traditional mortgage financing. They’re typically used when buyers are unwilling to get a mortgage through a bank or other mortgage originator. They may also be unable to get a mortgage due to their credit situation or other qualification reasons.
It’s for this latter reason that land contracts have seen growth and been considered a viable option after the mortgage crisis of 2007 – 2010. Those who have experienced a foreclosure or short sale may be able to use a land contract to get into a home when they might not otherwise have been able to. According to the U.S. Census Bureau, there were 9.649 million land contracts on the books as of 2015, the most recent year for which data was available. For reasons relating to the mechanics of land contracts and the laws surrounding them, this figure is almost certainly underreported.
This article will go over the pros and cons of loan contracts. Although they can be helpful, they certainly have their downsides. It’s really important to read your contract before signing on the dotted line. We’ll tell you what to watch out for and when to consider refinancing into a traditional mortgage.
What Is A Land Contract?
A land contract is a written legal contract, or agreement, used to purchase real estate, such as vacant land, a house, an apartment building, a commercial building or other real property. A land contract is similar to a mortgage, but rather than borrowing money from a lender or bank to buy real estate, the buyer makes payments to the real estate owner, or seller, until the purchase price is paid in full.
Depending upon the legal or common real estate terminology in your area, you may see these types of deals referred to as either land contracts, installment land contracts, contracts for deed, memorandums of contract, real estate contract or bonds for title.
When you get a mortgage, they tend to be structured so that they can be sold to major investors in the mortgage market. Because of this, mortgages have a fairly standard set of formalized terms for what happens when you miss a payment or if there are any adjustments that need to be made to modify the loan. Land contracts are completely between you and the owner of the house, so every one of them could be a little bit different. You really have to be careful when negotiating to be sure that the terms don’t put you at too much of a disadvantage.
How Does A Land Contract Work?
A land contract is typically between two parties: the buyer, sometimes referred to as the vendee; and the seller, aka the vendor. In a land contract, the seller agrees to finance the property for the buyer in exchange for the buyer meeting the terms agreed upon in the land contract.
In a traditional land contract, the seller keeps the legal title to the property until the land contract is fully paid off. Meanwhile, the buyer gets equitable title, which enables them to build up equity in the property. This will be important in a minute when we talk about the option to pay off your land contract by converting it to a regular mortgage.
There’s also something called a wrap-around land contract. Essentially, the buyer and seller agree to a seller-financed land contract, but the seller keeps paying on their existing mortgage, pocketing the difference between their mortgage payment and what they are paid on a monthly basis by the buyer. Unlike a straight land contract, the buyer in a wrap-around land contract gets the deed to the property immediately. They own the home. However, the seller’s lender has to agree to a wrap-around land contract. This is because they won’t be getting the full payoff amount. They also take a junior lien position in these agreements so they can take the home back if the seller holding the underlying mortgage stops making the payments.
Land contracts are typically paid in installments due at periodic intervals as agreed between the buyer and seller. At the end of the term, there may or may not be a balloon payment, a lump sum that must be paid in order to satisfy the loan terms.
What Does A Land Contract Cover?
A properly executed land contract has several pieces to it. Here are a few of the basic items covered:
- Sales Price: This covers how much the property is being sold for. Once you pay off this amount of principal, your obligations under the land contract are over. If it’s a straight land contract, you’ll get the legal title at the time of payoff.
- Down Payment Amount: This is due at your closing and may be expressed as a percentage or a flat amount in your contract.
- Interest Rate: The interest rate is defined, as are terms around whether the rate can ever change. If it can, the timing and conditions under which the interest rate could change should also be defined.
- Payment Amounts: The amount of your payment should be spelled out along with how often it needs to be made, monthly or otherwise. The contract may have specific due dates and late fees. It will also include whether there’s any balloon payment due at the end of the loan term. You should also be aware of whether the contract includes any penalty for paying off the loan early.
In addition to the basics, there should be clauses in the contract stating the responsibilities of the parties to each other. The buyer will be agreeing to make the mortgage payment. For the benefit of both parties, there should be clear language in the contract regarding what happens if the buyer falls behind on their payments. If any missed payments are allowed, what’s the timeline for paying them back and under what conditions might the buyer become delinquent to the point that the seller takes the property back?
From the buyer’s perspective, you’ll want language that says you get the legal title once all terms of the loan are satisfied. If it’s a wrap-around mortgage, it’s a good idea to have it written in that the seller will make payments on the underlying existing mortgage. That way, if the seller doesn’t make the payments and the buyer loses the house because of it, they have the option of legal action. You may also want a clause that requires the seller to keep careful track of your history of payments. This will make paying off your land contract with a conversion to a traditional mortgage easier later on.
Pros And Cons Of A Land Contract
Now that you know how land contracts work, it’s time to decide whether one is right for you. While there may be benefits of a land contract for certain buyers, there are also potentially significant downsides. It’s important that all parties to a potential land contract are fully aware of the benefits and risks involved. While a land contract may make sense in certain situations, it’s not for everyone and there may be better options available. It’s important to fully think through the pros and cons.
These are the potential benefits of a land contract from the perspectives of both a buyer and a seller:
- Easier To Get Financing: Land contracts make home financing an option for buyers who might not be able to get it through the traditional means of a mortgage. They can get into a home while continuing to work on their credit.
- Win-Win For Sellers: The seller accomplishes the goal of selling the property while still getting a periodic income stream throughout the term of the contract. If the buyer doesn’t make the payments, they can take the property back pursuant to the terms of the contract.
- More Purchase Opportunity: A buyer who needs a bigger space, but can’t qualify for it under traditional home loan guidelines may be able to obtain the property through seller financing and then pay off the land contract down the line through a mortgage once the balance is smaller.
Although land contracts may be useful in certain instances, they also come with major catches:
- Buyer Depends On The Seller: As a buyer, you’re placing a ton of trust in the seller. For instance, if it’s a wrap-around land contract with an existing mortgage still being paid off by the seller, the buyer can lose the home through no fault of their own if the seller doesn’t make the payments.
- Contract Vagueness: You have to really go in and make sure that the contract is ironclad around the responsibilities of each party. You’ll want to know going in exactly what the payment terms are, if they can change and under what circumstances. You want in writing that you get legal title to the property no later than when the principal is paid off as defined by the sale price of the property.
- Higher Interest Rates: The seller knows that you’re looking to do a land contract likely because you can’t be approved for a standard mortgage. Because the seller is taking on the higher risk, they’ll probably charge you a rate that’s higher than current market interest rates for traditional mortgages.
- Homeownership Gray Area: In a straight land contract, you receive equitable title so that you gain equity as you make payments on the loan from the seller, but the seller holds legal title until the property is paid off. This could cause issues around who owns the home if there are any legal disputes or insurance claims that need to be filed. This is further complicated by the fact that many jurisdictions don’t require that the land contract be recorded with the county. For this reason, it’s not really even possible to get a sense of how many land contracts exist in the U.S. The ones in the census numbers are those that are voluntarily reported. That means in many cases, unless the contract is shown in a legal proceeding, the only parties that would know about it would be the buyer and seller.
Converting A Land Contract Into A Traditional Mortgage
For buyers who are able to take the time to get their credit in shape and work to meet other qualifying standards, you can get better terms and/or pay off a balloon payment by converting your land contract to a traditional mortgage. The lender may verify the value of the property. You’ll also need the following items in addition to standard income, asset and credit checks.
- A Copy Of The Fully Executed Land Contract: The lender will need to know the balance they’re paying off in order to determine the loan amount. They’ll also want to make sure any underlying mortgage in a wrap-around contract would be paid off so that the title is clear.
- Payment History: It’s important to provide the lender with as long a payment history on your land contract as you can get your hands on. They’ll use this to verify your qualifications.
Hopefully this has helped you better understand the basics of land contracts and when they might be right for you. If you would like to look into converting your existing land contract into a traditional mortgage, you can start by applying online with Rocket Mortgage® by Quicken Loans®.
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|Loan Option||Rate / APR|
|30-YEAR FIXED*||3.25% / 3.676%|
|15-YEAR FIXED*||2.625% / 3.115%|
|VA 30-YEAR FIXED*||2.75% / 3.089%|
|FHA 30-YEAR FIXED*||2.625% / 3.898%|
15-year Fixed-Rate Loan: The payment on a $247,000 15-year Fixed-Rate Loan at 2.625% (3.115% APR) is $1,706.83 for the cost of 1.875 point(s) due at closing and a loan-to-value (LTV) of 92.51%. One point is equal to one percent of your loan amount. Payment does not include taxes and insurance. The actual payment amount will be greater. Some state and county maximum loan amount restrictions may apply.
30-year Fixed-Rate VA Loan: Rate is fixed. The payment on a $247,000, 30-year fixed-rate loan at 2.75% and 92.51% loan-to-value (LTV) is $1,008.36 with 1.50 Points due at closing. The Annual Percentage Rate (APR) is 3.089%. Payment does not include taxes and insurance premiums. The actual payment amount will be greater. Some state and county maximum loan amount restrictions may apply. VA loans do not require PMI. The VA loan is a benefit of military service and only offered to veterans, surviving spouses and active duty military.
FHA Loan: Rate is fixed. The payment on a $247,000, 30-year fixed rate loan at 2.625% and 92.51% loan-to-value (LTV) is $1,155.08 with 2.375 Points due at closing. Payment includes a one time upfront mortgage insurance premium (MIP) at 1.75% of the base loan amount and a monthly MIP calculated at 0.8% of the base loan amount. For mortgages with a loan-to-value (LTV) ratio of 92.51%, the 0.8% monthly MIP will be paid for the first 30 years of the mortgage term, or the end of the mortgage term, whichever comes first. Thereafter, the monthly loan payment will consist of equal monthly principal and interest payments only until the end of the loan. Payment does not include taxes and insurance premiums. The actual payment amount will be greater. Some state and county maximum loan amount restrictions may apply. The Annual Percentage Rate (APR) is 3.898%.
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