Land Contracts: How They Work, and Why They Can Be Good for You

In an environment where it is difficult for some buyers to qualify for financing with a traditional mortgage, a land contract may be a viable option. A land contract is also called a Contract for Deed, or an Installment Land Contract. Regardless, they all work the same.

The way a land contract works is that the seller retains legal title to the property and the buyer acquires what is called equitable title. This means that the buyer has the legal right to possess and use the property for their own purposes as they fulfill their obligations under the land contract.

The main obligations of the buyer are to make the payments under the contract, to pay the real estate taxes for the property, and to pay the insurance. The payments on the contract are typically due monthly at a specified interest rate and term, which can range anywhere from one to five years or more. The payments are based on the amount of the purchase price that is financed by the seller. Most sellers will require a down payment of 10%-20% of the entire purchase price, and that balance is the amount carried over for financing. An interest rate is charged on the amount financed.  It is always a good idea to have an amortization schedule run so that these can be clearly defined and calculated in the principle and interest payments under the contract. It is also important that the interest rate charged does not violate your state’s specific usury laws.

Contract payments can be set for a number of years with a balloon payment at the end. This means a certain monthly amount is paid every year, going to principle and interest, and when the end of that term is reached, the balance of the entire purchase price becomes immediately due to the seller. In this situation, the buyer would either have to pay off the entire amount in cash or finance it through a traditional mortgage to pay off the balance of the contract.

Another payment option is simply to make monthly payments until the entire balance of the purchase price is paid in full. Once the buyer completes their obligations for payments and any other obligations under the contract, the seller then has the duty to convey the title in full to the buyer. This typically is done with a warranty deed.

In the event that the buyer defaults on their payments or obligations under the contract, there is a mechanism for the seller to either foreclose or cancel the contract, and get the property back. These methods can be statutory or common law that is specific to the laws of the state where the property is located. A land contract foreclosure has the advantage of being a quicker recovery by the seller than the traditional mortgage foreclosure action. If the buyer is still in possession of the property after their redemption rights have been terminated, the seller would then have to proceed with an eviction action to physically remove the buyer from the property.

As you can see, a land contract is an option when a seller is dealing with a buyer who cannot qualify for conventional financing. Granted, there are risks for the seller, but a land contract can fill a nice niche when the traditional methods of purchasing real estate are not available.

Attorney Robert J. Carlson