Land Contracts: What They Are And How They Work

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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.

Although they can be helpful, loan contracts certainly have their downsides, so it’s important to read your contract in full before signing on the dotted line. In this article, we’ll examine the pros and cons of loan contracts, go over what to watch out for, and learn when to use a refinance to convert your land contract 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.

As a type of specialty home financing, a land contract is similar to a mortgage. However, 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 on 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, land sale contracts, contracts for deed, memorandums of contract, real estate contracts or bonds for title.

How Is A Land Contract Different From A Mortgage?

Mortgages tend to be structured so that they can be sold to major investors in the mortgage market, such as Fannie Mae and Freddie Mac. Because of this, mortgages have a fairly standard set of formalized terms for what happens when you miss a payment or when any adjustments need to be made to modify the loan.

Unlike traditional financing, land contracts are completely between you and the owner of the house, so each one will likely look a bit different. As a buyer, you really have to be careful when negotiating to ensure 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, also known as 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.

Traditional Land Contract Vs. Wrap-Around Land Contract

Let’s compare two ways to structure a land contract:

• Traditional land contract: In this type of 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 and can allow them to pay off their land contract by converting it into a regular mortgage, which we’ll discuss later.
• Wrap-around land contract: In a wrap-around land contract, the buyer and seller essentially agree to a seller-financed land However, 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 warranty deed to the property immediately, meaning they own the home from the beginning of the contract.

One key difference between traditional and wrap-around land contracts is that the seller’s lender has to agree to a wrap-around land contract because they won’t be getting the full payoff amount. The lender also takes 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.

Otherwise, both land contracts typically have installment payments due at periodic intervals as agreed between the buyer and seller. At the end of the term, the buyer may or may not need to make a balloon payment, which is a lump sum that must be paid to satisfy the loan terms.

What Does A Land Contract Cover?

A properly executed land contract has several components. Let’s look at a few of the basic items.

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 and will take possession of the property at the time of payoff.

Down Payment Amount

Your down payment is due at your closing and may be expressed as a percentage or a flat amount in your land sale contract.

Interest Rate

The interest rate is defined in the land contract, 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 the payment needs to be made, monthly or otherwise. The contract may include specific due dates and late fees, as well as whether a balloon payment is 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.

Responsibility Of The Parties

In addition to the basics, the contract should include clauses stating the responsibilities of the parties to each other – for example, whether the buyer will be agreeing to make the mortgage payment.

For the benefit of both parties, the contract should have clear language regarding what happens if the buyer defaults – or falls behind – on their payments. If any missed payments are allowed, the contract should explicitly state the timeline for paying them back, as well as under what conditions the buyer might become delinquent to the point that the seller takes the property back.

Title Settlement

If you’re the buyer, 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.