If you’re tired of paying rent but don’t qualify for a mortgage, a land contract could be your ticket to home ownership. Or if you own a home you need to sell fast in a slow market, a land contract could make that sale happen quickly—and for more money than you might get from a buyer with a conventional mortgage.
Land contracts: An overview
A land contract is basically a rent-to-own plan. Instead of borrowing from a bank, the seller finances the purchase of a home, condo, lot or commercial building. In return for eventual ownership, the buyer makes monthly payments to the seller. There is usually a down payment, and often a balloon payment after a few years of installments. Realtors can help buyers find sellers willing to finance; you can also check local “for sale by owner” listings.
What’s the advantage of land contracts?
In a word, speed. Because there’s no bank involved, land contract closings can happen in under a week—and without expensive closing costs.
Buyers with poor or no credit can get a land contract because it’s up to the seller to decide if they’re creditworthy. Down payments and closing costs—if any—are much smaller than with a mortgage.
Sellers can get a higher price than they would from a conventional buyer because they are surrendering possession before getting paid in full. And if the buyer defaults on payments the seller can keep the property—and all the payments made so far—although the rights of buyers and sellers vary from state to state. Finally, sellers usually don’t need to pay off any underlying mortgage to the property; instead they can make mortgage payments with the buyer’s installments, pocketing any profit.
And the downside?
The primary risk to buyers is they don’t build equity with their payments, even though they are paying property tax and are liable for all repairs (like a new furnace or roof). If you can’t make the balloon payment you risk losing the property, and all your monthly installments to date. Essentially, you’re just paying rent until the final payment, although courts are often sympathetic to buyers who’ve been paying in for years and may order some compensation.
Like any lender, sellers run the risk of a buyer defaulting. The buyer could also not pay property tax (for which the seller, as owner, is ultimately responsible). Evicting deadbeats and foreclosing on their contract can be complicated. If you have an underlying mortgage, the bank could theoretically demand full payment if you sell the property under a land contract—it’s known as “calling in” the loan and it’s written into so-called acceleration clauses in all mortgages. But in practice it’s rare.
You’ve come to an agreement—now what?
Land contracts are legitimate alternatives to mortgages, but fraudsters have been known to prey on buyers who aren’t financially savvy. Both sides of a deal should hire a real estate lawyer to oversee the details. You’ll need a purchase agreement and a contract with the legal description of the property, the payment schedule and payment dates.
Many states require disclosure statements about the condition of the property; buyers should receive an equitable title, which prevents the owner from re-selling to a third party or taking out liens on the property. The deed should be signed by the seller at closing and held in escrow by a lawyer or title company until the last payment is made, at which point ownership is transferred to the buyer.