Land contracts, sometimes called contracts for deeds or installment sales, are a form of seller financing. Under a land contract, the seller holds the title of the property and the buyer makes payments to him, much like making a monthly mortgage payment. After the buyer fulfills the term of the contract, the seller releases the title. While a land contract can be very buyer friendly, they also have some drawbacks.
Getting Approved for a Mortgage
Getting a mortgage requires you to go through a bank's process. Typically, the bank will check your credit, make sure that you have stable income, and determine that you can afford to pay on the mortgage. When you take out a contract for deed, you just need to convince the seller to do business with you. In many cases, this can make it easier for you to buy a house. One of its drawbacks is that you may end up buying a house that you can't afford.
Price, Terms and Flexibility
Since a land contract doesn't involve a third-party lender, you and the seller negotiate financing terms. As long as you can come up with a structure that works for both of you, you can do it. This can lead to much more flexible terms. Another benefit of a contract is that you don't have to pay a lender's origination or closing charges, which frees up money. You might also be able to buy the house without putting up a sizable down payment.
Land contract transactions have two potential drawbacks for buyers, though. The first is that many are structured with balloon payments in the future, meaning that, at some point, you will have to refinance them with a traditional loan. The second is that many sellers may charge a slightly higher interest rate than what a bank would charge for a traditional mortgage.
Rights of Ownership
In a land contract transaction, the title for the property effectively gets split. Under the contract, the seller retains the legal title, meaning that he is technically still the owner of the property. You, as the buyer, get equitable title, meaning that you have the right to act as if you are the owner. As an equitable title holder, you can occupy the property, take out a loan against it, if you can find someone to lend to you, or sell it, subject to the terms of your contract. The property is essentially yours, except that it isn't.
Exposure to Seller
When you buy a property on a contract, not only is it not completely yours, but you're also going to be tied to the seller for a period of years. Your contract could give your seller rights that a traditional lender would not have, including the ability to foreclose for a late payment. If your seller has a mortgage and fails to pay it, you could also end up losing your property when his lender forecloses on him.
The Seller's Perspective
For sellers, land contracts can solve two big problems. First, they turn properties into long-term streams of cash flow, which can be desirable. Second, they let sellers spread the receipt of their capital gains out over a long period of time. In exchange for these advantages, contracts have a significant drawback. When a seller sells on a land contract, he remains involved with the property. He doesn't get his money back until the contract's terms get fulfilled and, if something goes wrong, he could end up having to take his contract back.
- Bankrate: Land Contract - A Surprising Mortgage Alternative
- Kreis Enderle: The Benefits and Pitfalls of Real Estate Land Contracts
- Nolo. “Seller Financing: How It Works in Home Sales.” Accessed March 9, 2020.
- New York State. “Real Estate License Law,” Page 37. Accessed March 9, 2020.
- Federal Reserve Bank of St. Louis. “Local Predatory Lending Laws: Going Beyond North Carolina.” Accessed March 9, 2020.
- Cailber Law, S.C. "Land Contracts.” Accessed March 9, 2020.
- California Legislative Information. "Article 3. Disclosures on Purchase Money Liens on Residential Property." Accessed March 9, 2020.
- LendingTree. “Your Guide to Rent-to-Own Homes.” Accessed March 9, 2020.
- IRS. “Topic No. 705 Installment Sales.” Accessed March 9, 2020.
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.