What is a Land Contract and How Does It Work?
A land contract is a way to buy and sell real estate without involving a bank or other third-party lender. The seller finances the purchase, the buyer pays for it in installments and the title remains in the seller’s hands until the loan is paid in full.
Also known as a contract for deed, land-installment contract, bond for deed, bond for title or agreement for deed, a land contract is a form of seller financing that may appeal to buyers or sellers who want an alternative to a traditional mortgage.
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Land contracts: What are they?
Land contracts are a private agreement between a buyer and seller, which makes them a unique option when compared to traditional mortgages. They can be used to buy and sell undeveloped land, or land with a range of home types already built, including condos, single-family and multifamily homes. Typically, the buyer gets to move in immediately and receives equitable title to the property, but no equity. The seller maintains legal ownership until the full amount is paid. The buyer will then make payments for a number of years, usually concluding in a balloon payment.
For buyers with low or no credit, contracts for deed can be an appealing way to enter the real estate market without meeting traditional mortgage requirements. For sellers with properties that are difficult to get traditional financing for, or whose target market of buyers isn’t willing or able to pursue a traditional mortgage, a land contract can provide a way to attract buyers.
However, it’s important to know that land contracts have historically been to the seller’s advantage. In entering a private agreement, buyers give up some of the rights they would enjoy under a traditional mortgage or rental agreement. Because the owner maintains legal ownership until the full amount is paid, foreclosure and forfeiture remain a possibility and can in some cases be triggered by a single missed payment.
In some cases, land contracts also allow sellers to sell land they don’t themselves fully own. There’s nothing to require a seller who has an outstanding mortgage on the land to inform the buyer of that fact. This may not be a problem if everything goes smoothly, but if the seller stops making those mortgage payments, it can create huge problems for a buyer and even threaten their rights to the property.
While a land contract may sound similar to a rent-to-own agreement or a lease with a purchase option, it isn’t the same thing. If you sign a land contract, you’re agreeing then and there to purchase the property, not simply keeping the option open. However, there’s one notable similarity between all three contract types: the buyer is usually required to make a large, nonrefundable payment upfront. For a land contract, this is the down payment; for a rent-to-own or lease agreement, this is the “option fee” you must pay to keep open your option to purchase in the future.
How a land contract works
Here’s a step-by-step overview of how a buyer would find and enter into a land contract:
Identify a land contract home. Real estate agents, listings and specialized services for land contract homes all help buyers and sellers interested in this type of sale find each other. You can also do online searches for terms like “owner financed land near me” or “land contract homes for sale” to identify the options in your area.
Negotiate the land-purchase agreement terms.Professional help is a must because the laws around contracts vary from state to state, and you must ensure the contract terms are in your best interest and enforceable. If you can’t afford a lawyer, seek out low- or no-cost assistance from law clinics, housing nonprofits or legal aid organizations.
Do your due diligence. The best way to avoid costly surprises down the road is to do research and investigate before signing the contract. Typical due-diligence steps include:
→ Complete a title search. Public records can confirm who has legal ownership of the property as well as who has any claims to it or liens on it.
→ Use an escrow service. Placing the deed with a third party until the property is fully paid for can help ensure that everyone holds up their end of the deal.
→ Arrange an inspection. A home inspection will establish the condition of the home, its structural elements and exterior, as well as its major systems (like electrical, plumbing and heating) if applicable.
→ Get an appraisal. Without a professional estimate of the property’s value, you won’t know if you’re overpaying. If you want to cut costs, a broker price opinion is a cheaper alternative to a home appraisal.
Sign the land contract. A contract for deed will give the buyer equitable title, or the right to occupy and later take possession of the property, but the full transfer of the title doesn’t occur until the loan is fully paid off.
Move into the home. The buyer gets to take possession of the property before paying off the loan and gaining legal ownership.
Record the land contract. You may need to register the sale with the county in which the property is located, although not every state requires this.
Begin making installment payments.Payments may be sent directly to the seller or made through a servicing company. Failing to make payments or meet other contract terms means the buyer forfeits their rights to the property and loses all of the fees, payments and other investments they’ve made.
Pay off the loan.The buyer gains full title to the property after repaying the loan in full or refinancing it.
Land contract interest rates and terms
A typical land contract might be for five to 10 years, involve a balloon payment and carry an interest rate higher than traditional mortgages. However, land contract terms can vary greatly because these types of contracts are loosely regulated and any terms not explicitly regulated by law are totally up to the buyer and seller.
Buyers who successfully navigate a land contract often refinance after a few years to enter the traditional mortgage market, which offers more protections and lower rates.
How to calculate interest rates on land contract homes
Depending on the terms of the agreement, payments on a land contract may be interest-only or include the principal amount.
Luckily, you don’t need a special land contract calculator to figure out how much you might pay. For an interest-only payment, simply multiply the amount financed by the interest rate, and divide the result by the number of installments in a year. For example, the monthly interest payment on a $200,000 land contract home with an 8% interest rate after a 10% down payment would be $1,200.
If your payments include principal, the interest portion of the installment payment will decrease as the loan progresses and will be different for each payment.
What to look for in a land purchase agreement
→ Complete payment terms. The contract will specify the purchase price, down payment amount, payment schedule, installment amounts, interest rate, loan term and balloon payment amount (if applicable).
→ Responsible party for home repairs. The buyer and seller should agree upfront about who will make and pay for home repairs.
→ Responsible party for paying property taxes and homeowners insurance. The contract should specify who will be responsible for making tax and insurance payments, but ultimately the buyer will usually foot the bill.
→ Default procedure. In the case of default, the contract should specify the penalties, the buyer’s options and the seller’s options.
→ Additional provisions. These can stipulate when the buyer gains legal title and whether they can make changes to the property or transfer their interest in the property to another party without notifying the seller.
Pros and cons of buying land contract homes
Although land contracts have a bad reputation, they certainly aren’t always a bad idea. It’s essential, though, to understand why this type of sale has historically been exploitative: it opens buyers up to additional risks they wouldn’t face in the private mortgage market.
Here are some of the main advantages and disadvantages of a contract for deed for a potential buyer:
Provides an alternative for buyers who don’t qualify for traditional financing
Buyers may be able to negotiate an affordable down payment and installment payments
The process can be more flexible for buyers because a land contract doesn’t have to meet strict rules or regulations — the buyer and seller just have to agree
Closing costs are lower because loan origination fees and many of the other fees and costs typical of a traditional mortgage don’t apply
Less time to close because a third-party lender isn’t involved
Alternative to a small-dollar mortgage and its higher closing costs and interest rates
Can be refinanced once the buyer rehabs their credit, which can allow a buyer who didn’t qualify before to enter the traditional mortgage market
Higher purchase price and interest rate than a traditional purchase agreement
Buyer forfeits rights to the property and all payments made if they default
Buyers may be unaware of outstanding liens on the property, which could affect their legal right to ownership
Fewer protections than in traditional transactions, which means you may not have a foreclosure process and can be evicted more quickly
Legal title is withheld until the loan is completely paid off
Buyer can't use the land as collateral nor gain equity until the land is fully paid off
Unforeseen circumstances can result in the buyer losing the house/land (e.g., seller goes bankrupt, dies, stops paying taxes or their mortgage)
Refinancing is possible but may be difficult
How to turn a land contract into a traditional mortgage
It’s almost always safer and more cost-effective to have a traditional mortgage than it is to have a land contract. For this reason, it’s common for buyers to refinance with a traditional lender as soon as they can. As long as the title of the property under the land contract is clean — meaning it has no liens or levies against it and no other outstanding issues — you should be able to refinance as soon as your credit, income and debt-to-income (DTI) ratio meet the minimum requirements.
Alternatives to a land contract
→ A low- or no-down-payment mortgage. There are many options for homebuyers who want to put down less than 20% on a mortgage. Government-backed loan programs from the Federal Housing Administration (FHA), U.S. Department of Veterans Affairs (VA) and the U.S. Department of Agriculture (USDA) even allow you to buy a home with little to no money down.
→ Down payment assistance. There are federally supported programs in every state that provide assistance to buyers struggling to come up with a mortgage down payment.
→ A portfolio loan. This type of loan doesn’t have to conform to as many rules as conventional mortgages, which means that it can provide buyers with some special features, including lower down payments or the ability to avoid private mortgage insurance (PMI).