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A land contract is an agreement also known as a contract for deed or land installment contract.

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What is a Land Contract?

A land contract is a type of real estate transaction where the seller provides financing to the buyer. The buyer will then pay the agreed upon sales price in installments over a specific period of time. The payments made to the seller are made up of a combination of both principal and interest, similar to a typical mortgage. A balloon payment is often a put in place at the end of the contract.

Other Names for Land Contract

  • Contract for deed
  • Land installment contract
  • Agreement for deed
  • Installment sale agreement
  • Agreement to purchase and sale

Why Are Land Contracts Used?

One of the primary reasons why a land contract may be used to facilitate a real estate transaction is because the buyer may want to purchase a property, but be unable to obtain a bank loan. In these situations, the buyer and seller can skip the bank loan and enter into a land contract where the buyer can take possession of the property and make monthly payments to the seller to complete the transaction. While the seller is not paid all of the money up front, as would be the case with a traditional bank loan, the seller benefits because by offering a land contract, they attract more potential buyers and can negotiate a higher price for the property.

Lease to Own vs Land Contract

It is important to understand the difference between "lease to own" and a land contract. In a lease to own purchase, which can also be called a lease option, lease purchase, rent to buy, or owner-financing, the renter or tenant pays a down-payment to rent the property with an option to purchase it at any time during the rental period.

This gives the renter the legal right to purchase the property for a fixed period of time, but with no obligation to actually do so if they decide not to or if they are ultimately unable to qualify for a loan.

In a lease to own purchase, the down payment is usually non-refundable but will be credited to the purchase price of the real estate if the renter decides to buy. The monthly rent payments, however, are just rent and do not count towards the purchase of the property.

The deadline for purchasing (usually 1-4 years, depending on how soon the seller wants or needs to conclude the transaction) is usually agreed upon upfront by negotiation and will be listed in the lease contract.

With a land contract, the down payment counts towards the purchase price and the monthly payments count toward principal and interest. This means that each monthly payment brings the principal amount owed down each month.

Types of Land Contracts

Installment Sale Land Contract

One way to accomplish a land contract sale is with a very pro seller method called an installment sale. In this scenario, the title stays with the seller or in escrow with a title company or an attorney, and the buyer makes installment payments to the seller, but does not receive title to the property until the entire balance is paid off.

All inclusive or wraparound land contracts

Another way to execute a land contract is with a wraparound or all inclusive land contract. A wraparound land contract is one that creates a new mortgage for the buyer that wraps around an existing mortgage still held by the seller, typically with a larger balance and higher monthly payment.

The buyer makes installment payments to the seller based upon the selling price of the property plus interest, much like he or she would have done if they had obtained a mortgage from a bank. They seller conveys the title to the property to the buyer and extends a mortgage, the proceeds of which he uses to make payments on the existing underlying mortgage.

An all inclusive trust deed (AITD) is type of wraparound where the seller deeds the property to the buyer and the seller takes back a note. In this fashion, the buyer makes payments to the seller on the note and the seller makes payments on the underlying mortgage and pockets the difference, if there is any.

Straight contracts

A wraparound mortgage where there is no difference between the amount the buyer pays to the seller and what the seller pays on the underlying existing mortgage is referred to as straight contract or mirror wrap because the buyer's mortgage mirrors the existing underlying mortgage.

Power of Sale

Wraparound contracts typically contain a power of sale clause. This power of sale clause gives a third party, called a trustee (typically a title company) the power to sell the property on behalf of the seller if the buyer defaults on the mortgage.

When the buyer defaults on the mortgage, the trustee issues a notice of default to the buyer. This notice alerts the buyer of the default and gives them a time frame in which they should make up the arrears or lose the property.

The procedure involved in a power of sale foreclosure varies from state to state, but generally begins when the borrower misses a number of loan payments and ends with the property being sold at auction to the highest bidder, unless:

  • The buyer pays back the loan in full;
  • Negotiates a loan modification with the seller;
  • Files for bankruptcy; or
  • Sells the property as a short sell.

Pros and Cons of Using a Land Contract

Pros

  • Land contracts attract buyers. Sellers often offer terms that traditional lenders don't offer. These terms often make it easier for the buyer to afford the property. Therefore, sellers usually get a lot of offers when they offer to sell with a land contract.
  • Little or no money down. Depending on the seller, a big down payment is usually not required with a land contract. The buyer can move in as soon as the land contract has been finalized.
  • Less strict financial standards. Sellers are usually less strict when it comes to approving buyers than are banks and other traditional lenders. So, it's easier for the buyer to qualify for the loan.
  • Easier route to ownership. Because the terms of a land contract are usually more flexible than a traditional mortgage, it is often an easier route to home-ownership. Even buyers with credit challenges may qualify for a land contract.
  • Interest deductions. Because the buyer is the legal owner of the property, he or she can claim interest deductions and real estate tax deductions when calculating their personal income taxes
  • The seller doesn't have to worry about missed payments. This is because laws allow the seller to easily cancel a land contract. There is no need for judicial action or to pursue a foreclosure. The seller can recover their property in a very short period of time, typically within sixty days.
  • What's more, if the buyer loses the contract, the seller doesn't have to return or refund any past payments that have already been received. So, the seller will get the property back and keep all of the money.
  • The seller will have a steady monthly income. This can benefit sellers who own the property outright. In most cases, the interest on payments made by the buyer is higher than the return on other types of investments.

Cons

  • Buyers are not protected under foreclosure laws. If the buyer misses a payment, the seller has a right to reclaim the property and cancel the contract without judicial action or a foreclosure process.
  • Repair and maintenance. In most cases, the buyer will be responsible for the care and maintenance of the property.
  • The balloon payment. The seller has the right to cancel the contract if the buyer is unable to make the balloon payment when it is due. It doesn't matter if the buyer made every installment on time. The seller still has the right to take the property back without returning any of the payments already made.
  • The seller keeps the title. With a land contract, the seller keeps the title and might continue to burden the property with more mortgages and liens.
  • The seller also needs to be the property manager. This means that the seller will have to:
    • Track and collect payments
    • Keep up with property taxes and insurance
    • Keep track of and report interest to the IRS
    • Keep a close  eye on the property to protect their investment
  • The seller must evict. As mentioned above, the seller does not have to worry about missed payments, but the process of evicting a buyer who has defaulted on the loan can be bothersome. Because the balloon payment at the end of the contract term is an over-sized payment, the buyer may not be capable of paying the entire sum. Even if past payments were never missed, the seller would have to either evict the buyer or  agree to extend the contract.
  • The seller assumes a great deal of risk. Most sellers assume that it is OK to enter into a land contract with an underlying existing mortgage because they will be able to pay off the existing mortgage when the buyer makes the installments and final balloon payment. However, there is always the risk that the buyer will default on the contract and render the seller unable to pay off the existing underlying mortgage.

How Do You Write a Land Contract?

Components of a land contract

A land contract must include information regarding the:

  • The seller
  • The buyer
  • The property
  • The selling price
  • The down payment
  • The installment and balloon payments
  • The length of the contract

It should also provide detailed information regarding:

  • Real estate taxes
  • Property insurance
  • How interest on the loan will be calculated
  • The penalties for late payment
  • Default procedures
  • Care and maintenance of the property

Legal Considerations

Vendee Rights

When the buyer, also known as the vendee purchases real estate, they are not only purchasing the property, but a bundle of rights that is endowed to them as the title owner. These rights are as follows:

  1. The right of possession. The right to take possession of the property and to be considered the owner of that property.
  2. The right of control. The right to control that property and to do with it whatever they see fit, as long as it does not violate any local laws.
  3. The right of exclusion. The right to exclude anyone they want from entering onto or using the property. The only exception to this rule is where there is an easement in place that gives others the right to come onto the property in order to access their own property. Buyers are usually made aware of any easements prior to purchasing.
  4. The right of enjoyment. The right to pursue any enjoyment or pleasurable activities that they see fit to enjoy on the property.
  5. The right of disposition. The right to transfer ownership of the property to another. Ownership can be transferred temporarily or permanently by gifting, selling, and in some case by leasing or renting the property.

Vendor Rights

Just as the buyer enjoys certain rights when purchasing land under a land contract, the seller, also known as the or vendor, has certain rights as well:

  1. The right to legal title. The vendor has the right to retain legal title to the property until the vendee has satisfied all conditions of the contract for sale.
  2. The right to a second mortgage. The vendor has the right to have a second mortgage on the property. If so, the vendor is required to make payments on the underlying mortgage in a timely fashion.
  3. The right to regain possession. If the vendee breaches the contract, the vendor has the right to 1) terminate of all vendee's rights in the property; 2) keep all of the payments already made on the property by the vendee; 3) evict the vendee and regain possession of the property. What's, more, in some cases, the vendor has the right to demand payment of the full balance of the contract, even if the vendee misses only one payment.

Responsibilities of both vendee and vendor

With a land contract, both the vendor and the vendee have responsibilities with regard to the property. In contrast to a traditional mortgage, the vendor keeps the deed to the property until the vendee has paid off the entire balance in full.

As a result, each party has different responsibilities with regard to insurance and real estate taxes:

  • Insurance - Generally, the vendor is responsible for insuring all of his or her personal belongings that stay on the property throughout the term of the contract. The vendee, on the other hand, is responsible for insuring his or her personal belongings, the property, and for liability insurance coverage.
  • Real Estate Taxes - Normally, the vendee assumes the real estate tax burden from the vendor.

When does a buyer become the new owner of the property?

While the buyer is making payments to the seller, the buyer possesses equitable title to the property. This means (assuming that the buyer continues to fulfill their part of the contract) that the seller cannot sell the property to a third party or put any other liens or encumbrances on the property that would compromise with the buyer's equitable interest.

However, the seller keeps legal title until the buyer pays off the entire balance. Once the entire balance is paid off and all conditions of the sale have been met, the deed to the property will be recorded with the county office where the real estate is located listing the buyer as the new legal owner of that property.  

Do you need an attorney to review a land contract?

Yes. Land contracts can be the best, or in some instances the only, solution available to those who want to buy or sell certain types of real estate. Real estate laws differ from state to state, therefore it is imperative that you retain the services of a local legal professional to draft a land contract that includes terms and conditions that will allow you to take action to protect your interest, if necessary.     

Consumer Protection Concerns

Due to rising concerns over the possibility that land contract sales may violate the Truth in Lending Act (TILA), the Consumer Financial Protection Bureau (CFPB) has been looking into how best to regulate these types of real estate transactions. Texas changed its laws in 2015 so that the legal title to a property is now automatically conveyed to the buyer whenever a land contract is filed with the appropriate office of the county in which the property lies. Although the seller relinquishes legal title to the property, he or she retains the right to place a vendor's lien against the property for the remaining balance of the contract.

Best Practices

Best Practices for Buyers

  • Be sure to have the property appraised.
  • Purchase title insurance.
  • Entrust an executed deed and the original paperwork to a reputable holding company.
  • Consult with an experienced real estate attorney.

Best Practices for Seller

  • Run a credit check on the buyer.
  • Make sure that both the seller and buyer's names are on the insurance policy.
  • Hire a company to collect payment on the contract.
  • Consult with an experienced real estate attorney.

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