If you’re considering purchasing real estate, be it a home, land, or commercial property, your first inclination may be to seek financing through a lender. However, in some cases, a land contract may also be an option.
A land contract is a form of financing that allows buyers to make regular payments directly to the seller or real estate owner in exchange for ownership. This is different than a traditional mortgage where a house or condo buyer finances the property through a lender and makes payments to the lender for the duration of the mortgage.
Though a land contract is not considered a traditional mortgage, the two share some similarities. For instance, both are legally binding documents that outline the terms of a real estate transaction. Both also typically require the buyer to make a set amount of payments over a specified period of time. Once the payment agreement is met in full, the legal title will transfer to the buyer who will then own the property outright.
Why would someone use a land contract?
This type of seller financing can make it easier for buyers and sellers by negating the need for mortgage approval. For buyers, this makes purchasing property easier even if they aren’t eligible for a traditional mortgage. For sellers, a land contract can give them access to more buyers, create a steady income, and potentially sell their property for a higher purchase price. But there are risks for both parties. Below you’ll find common questions and answers about land contracts to help you decide if one is the right option for you.
What a Land Contract Is & How it Works
A land contract is an official agreement between the buyer, or vendee, and the seller, or vendor. When entering into a land contract, the buyer will make regular payments, typically monthly, to the seller.
Payments include the principal balance as well as any interest. During the payment period, the seller will maintain ownership of the legal title. The buyer, however, will maintain what’s known as equitable title, which prevents the property owner from selling the property, using it as a lien, or engaging in other activities that would infringe upon buyer’s rights to the property. It is important to note that the seller’s inability to sell or otherwise act against the interest of the contract is achieved by recording the land contract in County Land Records.
Once the final payments are made, the seller transfers the title to the buyer, and the buyer owns the property outright. At that point, the appropriate paperwork will be filed with the county and any other required government parties.
The Terms of a Land Contract Include:
Though land contracts vary from state to state and often seller to seller, they typically each include the following:
Repayment term, or how long you’ll have to pay the home off in full. While many mortgages extend to 30 years, land contracts are typically shorter. This is particularly important to note since some land contracts will allow for monthly payment for a specific period of time at the end of which the buyer will need to make a balloon payment for the remaining balance.
Down payment, or a lump sum payment made at the start of the land contract. Though these vary, they are often lower than the traditional 20% required of a traditional mortgage.
Interest rate, or the “cost” of borrowing. Land contract interest rates are typically set by the seller and therefore vary.
Are Land Contracts The Same As Rent to Own?
No, land contracts are different from rent-to-own agreements. Both are considered a form of seller financing, but there are significant differences between the two. For instance, under a rent-to-own agreement, the seller is still responsible for things like property maintenance, insurance, and taxes. A land contract, on the other hand, is very similar to a mortgage in that those responsibilities and costs shift to the buyer.
Further, in a land contract, the buyer also gains many of the typical rights extended to a homeowner, like the ability to make home improvements or other alterations to the property. Under a rent-to-own agreement, those rights can be limited.
Finally, and perhaps most importantly, is expected ownership. In a rent-to-own agreement, the intended buyer often chooses to purchase the home for a predetermined price, but they are not necessarily obligated to do so. In a land contract, however, the agreement is a binding one in which the buyer agrees to purchase the home. Failure to make payments and carry out the agreement would result in a default.
Is it smart to use one?
That depends on your situation.
For home buyers, a land contract can be a good idea if:
- You can’t qualify for a traditional mortgage
- Have a poor credit history
- Can’t meet deposit requirements of a traditional mortgage
For home sellers, a land contract can be a good idea if:
- You’re looking for a built-in income with interest
- Your property has been on the market for a significant period of time
- There are limited buyers and you want to attract more
- You either own your home or are confident your current mortgage agreement will allow for a land contract
What Happens if a Buyer Doesn’t Pay Monthly Payments?
If a buyer doesn’t make the required monthly payments or defaults on the contract, the seller can take legal action against the buyer.
Up until the end of the contract, the buyer maintains an “equitable title,” which refers to, among other things, their right to work towards complete ownership of the property in question. This differs from the legal title, which is held by the seller until the buyer makes payment in full.
When the buyer fails to make payments, the seller can file a land contract forfeiture, which is a court action that ends the buyer’s equitable title. Once filed, the land contract is no longer valid and the buyer gives up all money previously paid as well as the future rights to the property. The seller maintains all monies paid as well as full ownership of the property.
Do Land Contracts Need to be Recorded With the State?
Real estate law varies from state to state, and so whether you need to record a land contract with the state depends on the state in which you live. For instance, sellers in Ohio are required to record the land contract within twenty days of signing. In Illinois, however, land contracts for residential property, also known as installment sales, must be recorded within ten business days of sale.
If you’re considering or in the process of entering into a land contract, consult a certified real estate lawyer in your state to find out exactly when and if you must record the contract with the state.
Who Pays Property Taxes on a Land Contract?
Typically, the buyer is responsible for paying property taxes on a land contract. However, in some cases, the buyer will only take on the financial responsibility and the owner will continue to make the actual payments, passing the cost along to the buyer.
Who Chooses the Interest Rates on a Land Contract?
The seller determines the interest rate on a land contract.