The three most common ways to pay for a home are with cash, using a mortgage, or by land contract. A land contract is a written agreement between the seller and the purchaser that ultimately results in transfer of the title to property once all terms and conditions of payment are met (a method of “seller financing”). Unlike the more typical ways of buying a house, however, the property doesn’t become “yours” until you have completely paid it off.
Why Would a Home Buyer Use a Land Contract?
If you’re interested in buying a home, but face some financial obstacles—perhaps you have a low credit rating, uneven employment history, or would have difficulty obtaining a mortgage for some other reason—you might try to buy property using a land contract.
A home seller might consider offering a home for sale by land contract in order to expand the pool of potential purchasers. When looking at homes for sale, the advertisement will usually say whether or not the seller will accept a land contract, next to the accepted forms of purchase. The most common forms of purchase are cash, conventional mortgage, Federal Housing Act (FHA) mortgage, or Veterans Affairs (VA) mortgage.
Land contracts are also commonly used to sell property that's been valued or priced so low that no bank or institutional lender would be willing to offer a mortgage for the sale. For example, many banks will not provide a mortgage for $20,000 or less even though the property value may be high enough to serve as security for the loan, because the total interest to be received is not high enough to balance the bank's cost and risk of making the loan.
When Ownership of the House Shifts to Buyer Under a Land Contract
If you buy a house using a land contract, you don’t become its full owner right away. Upon entering into the agreement, the buyer receives what’s called “equitable title” to the property, which lasts through the entire term of the land contract. By contrast, someone who buys a home with cash or a mortgage receives full title to the home at the closing of the sale (though, of course, the bank or other lender retains a “security interest,” allowing it to foreclose if need be).
What is equitable title? It means the purchaser has a legal interest in the property during the time period that he or she makes payments to the seller. The buyer can certainly live in the house and treat it as his or her own during this time. The transfer of legal title to the property, however, is held by the seller until the buyer has made the final payment on the land contract.
This arrangement can lead to a serious disadvantage if you fail to make the payments as arranged. In such a case, the seller can file a legal action against you in court, called a forfeiture. The forfeiture returns all legal interest in the home to the seller and allows the seller to keep all payments you have made toward purchasing the home. Although you may have invested multiple payments into owning the home, you will end up with no ownership right in it after the forfeiture action.
How Do the Home Seller and Buyer Figure Out Payment Amounts on a Land Contract?
The seller typically decides how much of a down payment he or she requires in order to enter into a land contract and how much the payments will be each month.
The typical payments would be a monthly amount calculated by the purchase price divided over ten years, for example, plus interest. This can all be negotiated, however. Since the seller is not receiving a check at closing for the full amount of the purchase price, like a seller would at a closing using cash or a mortgage, oftentimes the seller will require a larger down payment or higher monthly payments, or both, than a traditional mortgage would require. This helps reduce some of the risk the seller is taking on by becoming, in effect, your lender.
Summary of Differences Between a Land Contract Sale and a Mortgage-Financed Sale.
Using a land contract:
Using a mortgage:
What Terms a Land Contract Should Include
For legal as well as practical reasons, anyone entering into a land contract will want to make sure the entire deal is memorialized on paper. This process should involve drafting and signing a purchase agreement, (the so-called land contract) between the seller and purchaser.
Who drafts it depends in part on whose idea this is. The purchaser may, for example, prepare the initial draft and offer it to the seller in response to the seller’s advertisement to sell the property.
The land contract agreement should state the basic terms of the sale, such as the property address or description and the number of years over which payments will be made and at what interest rate, as well as the agreed-upon price for the home or property. While many mortgages are for 30 years, land contracts are often much shorter. It is helpful to attach an amortization schedule to the land contract so the parties are clear on the exact amount of payments to be made to the seller.
The land contract should also state whether any fixtures or appliances are included with the sale and the date of closing. Finally, there should be a period of time stated for which the purchaser can have the property inspected and would be able to negotiate any repairs based on the findings of the inspection.
Most likely with the help of an attorney, you might want to add other terms of the sale that both buyer and seller feel are important.
All of these items are just like a standard purchase agreement used when a property is purchased with a mortgage or with cash. If a seller is not satisfied with the purchaser’s version of the land contract, the seller can make a counteroffer with differing terms, and the purchaser may either accept the changes or make a counteroffer back to the seller.
How to Prove You “Own” the Property Before You’ve Paid It Off
If you are the buyer, the fact that you will be making payments to the seller for the property without obtaining a deed until all payments are made should probably worry you a bit. Fortunately, there’s a legal solution, known as a “memorandum of land contract.”
This is typically a single-page document that sets forth the date and purchase price of the land contract, the names of the seller and purchaser, and a legal description of the property. It should be signed by the seller. The memorandum of land contract will need to be filed with the appropriate registrar of deeds office so that the public is put on notice of your ownership interest.
Final Steps to a Land Contract Purchase
To protect yourself as the buyer, you may want to obtain title insurance for the property (as a bank would require if you were using a mortgage). This helps make sure the property is free and clear of any third-party interests, such as a mortgage, special assessment, or lien. The title company (or an escrow company) may also be able to perform the closing, at which you and the seller sign the land contract. The company can hold the deed in an escrow account until you’ve made the final payment, t to be sure the title is transferred as agreed.
Holding the deed in escrow means keeping it in a safe place, often a security box, until a triggering event occurs. The triggering event in a land contract sale is when the purchaser satisfies all of the terms of the land contract and makes the final payment due to the seller. At that time the title company would release the deed to the purchaser for recording with the registrar of deeds and the purchaser would become the legal title owner of the property.