What is a Land Contract?

A land contract is a form of “seller financing”.

A land contract is a contract between a buyer and a seller of a home, commercial property or other real estate where the buyer takes possession of the property, but the seller holds legal title to the property until all agreed upon payments are made in full. In this respect, it is similar to bank financing, except that under a land contract, the seller holds the legal title until full payment is received.

A land contract (in some states it is called a "contract for deed") purchase is attractive to a seller because it doesn’t depend on the lengthy bank approval (or rejection) process, and it increases the number of prospective buyers for their property, particularly helpful in a slow real estate market. The seller also determines the interest rate on the agreement, enabling the seller to realize a considerable profit from the monthly payments alone. (Click here to see an example of how a seller can make a worthwhile profit from selling on land contract.)

Land contract is attractive to a buyer who might not meet the credit requirements, minimum down payment requirements, length of employment requirements, or other requirements for bank financing. The initial costs associated with a land contract sale are also significantly lower than a sale with bank financing.

Usually under a land contract, the buyer makes a down payment, then makes monthly payments to the seller for a set period of time, frequently one, two or three years. At the end of that period of time, the buyer is bound by the land contract to pay off the balance owed to the seller. This is called a balloon payment, and more often than not, the buyer makes that balloon payment by obtaining a conventional bank loan (mortgage loan) once the objectionable portions of their credit or employment situation are improved.

Normally, the buyer makes payments that are figured (amortized) as if they had a 15 to 30-year bank loan so that the payments are more affordable, even though the buyer actually has to find a way to pay the seller in-full by the end of the land contract period. If the buyer is unable to obtain financing or otherwise make payment in-full at the end of the land contract, the seller may re-take the property, and the buyer loses any investment they’ve made, including down payment and equity gained through their monthly installments. In this respect, a land contract forfeiture is similar to a bank foreclosure.

 

How is a Land Contract different from Lease/Purchase Option?

Note: The Land Contract Store coordinates and manages both land contract and lease/purchase option sales. Our fees are the same for either financial arrangement, so we have no reason to promote one form of seller financing over another, except for the well-being of our client, the home seller.

In the current home finance market, we recommend seeking a buyer with whom you're comfortable entering into a land contract agreement. With the stringent standards now being imposed by banks, there are many good people who want to buy homes but are declined.

Our reasoning, which benefits both buyer and seller, is explained below:

Under lease/purchase option, a fixed portion of the buyer's monthly payment is credited toward a down payment on the house, should they choose to ultimately buy the house.  Any down payment and additional monthly installment (i.e paying $1000 p/month vs $925 p/month, with $75 going toward a potential down payment) is considered as buying an option to later purchase the house.

By contrast, under a land contract, a gradually increasing portion of the buyer’s payment is applied to the principal, with the portion applied to the principal increasing as time goes on, just as a bank mortgage payment would.

The greatest practical reasons for a seller to choose a lease/purchase option are down payment and resolution of issues if the buyer falls behind on payments. Under a land contract, a seller should require a significant down payment, 5% or higher.  Sellers sometimes choose a lease/ purchase option if the buyer has little or no cash for a down payment, which could be construed as less commitment to obtaining a bank loan and actually buying the house in two or three years. Under lease/purchase option, the buyer is legally a renter, so if they fall behind on payments, the seller can evict them within 30 days just as a landlord would on a renter who is behind on their payments. The Land Contract Store assists in eviction procedures, if it comes down to that, by providing legal authorities with payment, and payment collection effort histories.

Moreover, under lease/purchase option, the seller is still the sole owner, and depending on the agreement, could still be legally required to maintain the integrity of the property (repairs and upkeep), as well as taxes and homeowners insurance. Under land contract, the buyer has equity title to the property, and normally assumes upkeep, taxes and insurance on the property.

Another benefit of going with a land contract is that, once the land contract is recorded with the county, banks will view the buyer's subsequent application for a mortgage loan as a refinance rather than a purchase loan. This greatly improves the odds of the buyer obtaining bank financing before the end of the land contract term, providing full payoff to the seller at an earlier date. Normally, a bank will consider a buyer's application for a mortgage loan more favorably after they have made timely payments on a legally recorded land contract for 12 months.

The Land Contract Store will, as an unbiased third party, provide the bank which the buyer has applied to their payment history via The Land Contract Store, increasing the odds they'll be approved for a bank loan.