Land Contract vs. Mortgage

A land contact and a mortgage can feel very similar. Both usually require monthly payments of principal and interest, and both frequently require a down payment. However, the process to get either is very different, with land contracts usually being less complicated. Your legal status is also different, since under a contract you technically don't own the house.

When you take out a traditional home loan, it actually has two pieces. The promissory note is the agreement between you and the lender that specifies how you'll pay back the loan. The note also includes a clause that lets the lender take the property if you don't fulfill your obligations under the note. To allow the lender to foreclose on your home, a document called a mortgage or, in some states, a trust deed, also gets signed and filed against your property's title.

Also called a contract for deed or an installment sale, a land contract is an agreement under which the owner of the property agrees to give you ownership of the property once you complete your obligations under the contract. Typically, contracts require monthly payments and have a balloon payment some time in the future. At that point, you would obtain a regular mortgage to pay off the contract.

Obtaining a mortgage can be a long and drawn out process. Identify a lender that will provide the type of mortgage you want. The lender typically requires information about your credit, your job and your financial standing. Based on its findings, it either approves or denies your loan application.

When you take out a contract for deed, the lender is the seller of the property. As such, you can work with them to come up with rates and terms that work well for both of you. Furthermore, since you're not going to a bank for the money, you won't have to go through a complicated application process, although some sellers may still look into your financial history to ensure that you'll be able to pay off the contract.

When you have a mortgage, you own the property. As long as you pay your property taxes, meet the obligations of your promissory note and avoid having collections or liens filed against your house, it's yours to keep. With a contract for deed, you don't own the property until you pay off the contract. If something happens to the seller financially, they could lose the house that they already sold you. As such, a contract for deed can be a risky way to buy a property. Furthermore, even though the Internal Revenue Service treats it as a sale from the perspective of letting you write off your land contract interest, since you never bought the property, you usually won't have the protection afforded by foreclosure laws.