What is the definition of a land contract?
Buyers can get seller-financed options like land contracts instead of standard mortgages. When purchasers are hesitant to work with traditional mortgage lenders, they may turn to these alternative financing options. They might not meet the requirements for a mortgage, either because of their credit or for some other reason.
After the housing market collapsed between 2007 and 2010, land contracts gained popularity as a possible solution. A land contract can help people who have gone through a short sale or foreclosure get into a house when they might not have gotten a chance to do so otherwise.
It is critical to study your loan contract well before signing it, as there are benefits and drawbacks to this type of agreement. Read on to find out when it’s a good idea to utilize a refinance to turn your land contract into a regular mortgage, as well as the benefits and drawbacks of loan contracts and other related topics.
To buy land, a home, an apartment complex, a business building, or any other type of real estate, one must enter into a legally binding contract, often known as a land contract.
Land contracts are a kind of specialized home finance that are comparable to mortgages. But instead of taking out a loan from a bank or lending institution, the buyer pays the seller, who is also the owner of the property, in installments until the whole purchase price is paid.
Some names for these kinds of agreements are real estate contracts, bonds for title, contracts for deed, contracts for installments, land sale contracts, memorandums of contract, and contracts for deed.
What are the key differences between a mortgage and a land contract?
Major mortgage market investors like Fannie Mae and Freddie Mac are often the intended buyers of mortgages that are structured in a certain way. For this reason, there is a generally accepted set of procedures in mortgages for handling situations where a payment is late or when changes are necessary to the loan.
Since land contracts are solely between you and the property owner, they can take on a variety of forms, unlike more conventional forms of financing. Careful negotiation is required on the part of the buyer to avoid being unduly disadvantaged by the terms.
What Is the Process of a Land Contract?
The parties involved in a land contract are usually the seller (or vendor) and the buyer (or vendee) of the property. For the purpose of financing the property, the seller agrees to do so in a land contract, provided that the buyer fulfills the conditions laid out in the contract.
Comparing Land Contract Types: Traditional and Wrap-Around
Here are two examples of land contracts and how they compare:
- Traditional land contract: Under this kind of agreement, the seller retains legal title to the real estate until the debt is settled in full. As we’ll see later on, the buyer can change their land contract into a standard mortgage after they receive equitable title, which lets them create equity in the property.
- Wrap-around land contract: Under this type of agreement, the seller and the buyer basically consent to a seller-financed land deal. Still, the seller keeps making payments on their current mortgage and keeps the money that isn’t going toward their mortgage payment from the buyer each month. The buyer in a wrap-around land contract owns the home from the beginning of the contract since, unlike in a straight land contract, they acquire the warranty deed to the land immediately.
Since the seller’s lender will not receive the full payback amount in a wrap-around land contract, this arrangement differs significantly from regular land contracts. In these arrangements, the lender also takes a junior lien position, which allows them to reclaim the property in the event that the seller who holds the underlying mortgage defaults on their payments.
Aside from that, the buyer and seller usually agree on a schedule for when the installment payments are due in both types of land contracts. The buyer will be required to pay a fixed amount, known as a balloon payment, to pay off the loan in full at the end of the period.
What Is Covered by a Land Contract?
The elements of a well-drafted land contract are multi-faceted. Let’s have a look at the fundamentals.
Sales Price
This sums up the selling price of the property. Paying this principle sum will terminate your duties under the land contract. At the end of a straight land contract, you will own the property and have full legal title to it.
Amount of the Down Payment
Your land sale contract will specify the amount of your down payment, which might be a percentage or a fixed sum, and is payable at closing.
Rate of Interest
The land contract specifies the interest rate and any conditions about its potential modification. If possible, it would be helpful to specify when and under what circumstances the interest rate could vary as well.
Total Amount Due
There should be a clear indication of the total amount due as well as the frequency (monthly or otherwise) of payments. The contract can specify when payments are due, the penalties for being late, and whether or not there will be a balloon payment at the conclusion of the loan’s duration. Pay close attention to the contract to see whether there is a charge for repaying the loan early.
Participants’ Obligations
Aside from the standard fare, the contract should contain provisions outlining the respective duties of the parties. For instance, it should specify whether the purchaser is committing to paying the mortgage.
It is in everyone’s best interest for the contract to spell out exactly what would happen if the buyer is unable to pay as agreed upon. If there is a grace period for payments that are late, the contract should spell out how long the buyer has to pay them back and what happens if they go into default, allowing the seller to reclaim the property.
Title Settlement
As the buyer, you should seek out language that states you will receive the legal title upon full repayment of the loan. For a wrap-around mortgage, it’s wise to specify that the seller will also be responsible for paying down the original mortgage. The buyer will have legal recourse in the event that the seller defaults on the payments and the buyer loses possession of the residence.
It may also be wise to have a provision that the seller keep track of payments made. Having this history will make converting to a traditional mortgage down the road a lot easier.
A Land Contract: Benefits and Drawbacks
Having learned the ins and outs of land contracts, you should be aware that they aren’t appropriate for every buyer or circumstance. Before committing to a home loan, it’s a good idea to research all of your financing alternatives. Before adopting a land contract to close a real estate deal, you should have a thorough understanding of the pros and cons of doing so.
To assist you in determining if this form of financing is suitable for your needs, let’s examine the benefits and drawbacks of land contracts.
Benefit: Getting Financing Is Less Difficult
If a buyer is unable to secure a mortgage through more conventional channels, they may be eligible for land contract home financing. Although there are a variety of mortgages available, some of which are designed to accommodate borrowers with lower credit ratings, it is important to be aware of this before committing to a land contract.
Benefit: Sellers Profit Too
The seller achieves their objective of selling the property while still receiving a steady stream of money during the contract term. The seller has the right to reclaim the property as stated in the contract in the event that the buyer defaults on the payments.
Benefit: It Offers Additional Buying Opportunities
Seller financing might be an option for a buyer who wants more space but doesn’t meet the requirements for a conventional mortgage. After some time has passed and the debt on the land contract has decreased, they might use a mortgage to pay it off.
Drawback: The buyer relies on the vendor
You, the buyer, are putting a great deal of faith in the seller. For example, in a wrap-around land deal where the seller is still paying off a mortgage, the buyer can end up losing the house even if they didn’t do anything wrong if the seller defaults on the payments.
Drawback: Contract Imprecision
Get down to brass tacks and make sure the contract spells out exactly what each side is responsible for. Pay close attention to the details about the payment terms, including whether or not they are subject to alter and, if so, under what conditions. You should consult a lawyer before entering into any contracts, and you should think about getting a real estate lawyer to help you negotiate fair conditions.
It is recommended that you secure written documentation stating that you will acquire legal title to the property no later than the principle is paid off, which is often determined by the sale price of the property. You have the option to request a title search to verify the seller’s ownership and ability to legally transfer the property. If the property has any liens or encumbrances, such as unpaid taxes or other debts, a title search will show them.
Drawback: Greater Interest Rates
The seller is aware that you are looking for a land contract, most likely because a conventional mortgage is out of the question for you. The seller will likely charge you a rate greater than what you would pay for more conventional financing because they are taking on more risk.
Drawback: Uncertainty of Ownership
The buyer in a straight land contract acquires equitable title to the property and builds equity through loan repayments to the seller. Still, until the loan is paid off, the seller retains legal ownership of the property. In the event of a lawsuit or insurance claim, this can lead to confusion about who owns the house.
The fact that not all jurisdictions mandate recording the land contract with the county adds another layer of complexity to ownership. Because of this, it is exceedingly difficult to gauge the total number of land transactions in the United States. Voluntary reporting constitutes the contracts included in the census; thus, no one other than the buyer and seller would be aware to their existence unless proven in court.
Making the Transition from a Land Contract to a Conventional Mortgage
Buyers who are patient and satisfy other qualifying requirements can convert their land contract to a conventional mortgage, which allows them to pay off a balloon payment and get better terms.
Aside from the usual income, asset, and credit checks, the lender may request an appraisal to confirm the property’s worth:
- A duplicate of the duly signed land contract: When deciding how much to lend, the lender will want to know the current balance. under order to ensure clear title, they will also wish to pay off any underlying mortgage under a wrap-around contract.
- Loan repayment history: Give the lender as much documentation as you can regarding your land contract’s repayment terms. That’s how they’ll check your credentials.
Land Contracts: An Alternative for Homebuyers
If you are unable to get traditional financing due to poor credit, a land contract may be an option for you to become a homeowner.
But it’s also a good idea to apply with other lenders and compare their prices. Even if your application doesn’t pass muster with one lender, it can be enough to get you approved by another.
