If you are anxious to be a homeowner but find you cannot qualify for a traditional mortgage, there are a variety of alternative financing solutions to consider. Some choices, like lease option arrangements, offer little protection and no equity; tenants only purchase the right to buy the home at the lease term's end. However, installment land contracts, also known as "contract for deed" deals, give a buyer the rights of homeownership.
You theoretically have equity in a land contract home but you only get the benefit when you finish paying the installments and the title is transferred to you. If you don't make payments on time, the seller could foreclose and you;d lose all your payment and any uplift in the home's value.
Installment Land Contracts
Installment land contracts can be lucrative arrangements for buyers and sellers, but only if both parties are well-versed in deal terms. At its most basic level, it's a form of seller financing. The buyer purchases the home, provides a small down payment to the seller, usually 1 to 10 percent, and begins making mortgage payments directly to the seller, including interest, instead of a bank. The buyer also pays the property taxes and insurance, and is responsible for the upkeep of the home.
Contracts usually last between 5 and 10 years, after which the buyer refinances with a traditional lender and the seller is paid in full. What distinguishes a land contract deal from a traditional home sale is that the seller retains the deed to the home as collateral. The buyer earns equitable title through the down payment as well as his monthly payments. Deals are recorded with the city or town as a sale.
Equitable Title vs. Equity
"Equitable title" isn't the same as "equity," however. Equity is simply the difference between a loan and the value of the property. For example, a homeowner who owns a home worth $200,000 and has a mortgage of $150,000 has $50,000 equity. Equitable title is different. If you have an equitable title, it means you have the right to get an ownership interest in the property, but someone else owns the legal title. Upon payment in full of the contract price, the seller, known as the "vendor," transfers the full title to the buyer, known as the "vendee." The vendee reaps the benefit, but also the risk, of any change in value of the property during the contract term.
Why They're Used
Contract for deed arrangements are more common in difficult lending environments, when lending is tight and potential buyers may struggle to get the money they need through conventional banks and mortgage providers. Credit and financial requirements have eliminated many would-be buyers from the real estate market; however, land contracts allow these buyers to become homeowners. Since bank approvals aren't required, deals are consummated more quickly and with less paperwork. Closing costs are lower as well.
Sellers can earn a top selling price, a major plus, especially if the property has proven difficult to sell. They're also freed from the hassles of maintaining the property and paying taxes. Both parties can reap significant tax advantages. Buyers can deduct tax and mortgage interest expenses, while sellers may be able to spread out capital gains over the period of the loan term.
Advantages and Disadvantages
Buyers must make payments on time, else they may lose the entirety of their payments in the event the sellers decides to foreclose, often called "forfeiture" in land contract arrangements. Also, if the seller encumbers the home with a new loan or becomes delinquent in his own mortgage, the buyer could not only be evicted but would own a worthless contract. Because land contracts don't typically offer big down payments, sellers should be flush.
Also, if the buyer defaults, then forfeiture proceedings could take months and be expensive. Both parties must be willing to pay for good legal counsel as well as a thorough inspection and appraisal. Financial and credit history disclosures are helpful, too.
- NOLO: The Basics of 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.
Lisa Bigelow is an independent writer with prior professional experience in the finance and fitness industries. She also writes a well-regarded political commentary column published in Fairfield, New Haven and Westchester counties in the New York City metro area.