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.
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.
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.
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.
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:
Components of a land contract
A land contract must include information regarding the:
It should also provide detailed information regarding:
Types of Financing
Sometimes, the best way to sell a property quickly, is through seller financing. A land contract is essentially a real estate transaction where the seller provides financing to the buyer. The agreed upon price is paid in installments, commonly on a monthly basis, over a term of 3 to 5 years at an agreed upon interest rate.
The terms of a land contract will depend on what the buyer and seller agree upon, but are generally more convenient than those of a traditional lender. Seller financing is an good alternative to consider when:
Land contracts tend to be financed by the seller. But, occasionally a buyer will obtain traditional financing from a bank to fund the purchase of unimproved land by land contract.
A buyer wanting to develop unimproved land may prefer to finance the purchase of the land with a traditional bank loan. However, bank loans for the purchase of unimproved land usually come at higher interest rates and with shorter terms.
Furthermore, loans for unimproved land frequently come with a balloon payment in lieu of (or in addition to) a series of installment payments. Ordinarily, builders who receive loans for unimproved land refinance those loans with different loans once the land has been improved and has more collateral value.
How do Installment Payments work?
Similar to mortgage payments on a traditional bank loan, installment payments made under a land contract are part principle and part interest. The more installment payments the buyer makes over time, the greater his or her equity in the property becomes.
When a buyer gets a traditional loan from a bank to purchase property and the transaction is made, the buyer does not become the outright owner of the property right away. Instead, the bank keeps legal title to the property until the loan is paid off and a deed is issued to the buyer.
Similarly, with a land contract, the seller functions as the lender and will retain legal title to the property while the buyer receives equitable interest in the property. Legal title can then be defined as the right to sell, while equitable title can be understood as the right to use and possess.
When the buyer and seller enter into a land contract equitable title to the property being sold passes to the buyer. Then when all of the payments have been made, the buyer receives legal title to the property.
So, for example, if the buyer makes a $4000 down payment and borrows $16,000 for a piece of land priced at $20,000, and then pays another $8000 in installments (excluding interest), the buyer will have $12,000 of equitable interest in the property or 60% of the equitable title.
However, if the buyer fails to make all of the payments that are required, the seller can cancel the land contract. This will result in the buyer losing all of his or her equitable interest in the property, as well as, all of the installment payments he or she has made to the seller. To put it simply, if the buyer doesn't pay, the seller can keep legal title to the property and regain full equitable title as well.
A purchase default is a contractual mechanism that is meant to discourage the buyer from defaulting on the contract. A typical purchase default will allow the buyer to be notified of any missed payments. The buyer will then be subject to a late payment penalty and be allowed a certain amount of time to make up the missed payments.
If the buyer fails to make up the late payments in the time allotted, he or she will have a very short time to pay off the remaining balance of the loan in full and will be required to vacate the property within the timeframe specified in the contract.
If the buyer eventually manages to cure the defaults, the seller can opt to reinstate the contract, but only if he or she sees fit to do so. It is, therefore, extremely important that terms for repaying the loan be feasible, so that the buyer is less likely to default on the loan.
Acceleration Clauses in Underlying Loans
There are many different contractual clauses that can come up in regards to a land contract sale. If the seller still has an existing underlying mortgage on the property being sold, he or she should check the terms of that mortgage. This is because selling property via a land contract could be considered a default for the existing underlying mortgage and trigger what is called an acceleration clause in that contract.
The acceleration clause in a mortgage or trust deed is one that stipulates that if the owner of the mortgaged property sells or otherwise transfers title to that property to someone else, the mortgage becomes default under the terms of the contract and the entire balance of that mortgage becomes due and payable immediately. For this reason, if you are looking to offer a land contract for the sale of property with an existing mortgage, you should consult with an experienced real estate attorney before you proceed.
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:
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:
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:
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.
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