Land Contracts: What Are They?
Even when the real estate market is challenging like it is right now, there are many different financing options. One such option is the Land Contract. Let’s see if a Land Contract is right for you.
What is a Land Contract?
A Land Contract is a seller-finance alternative to your typical mortgage option. A Land Contract is similar to a mortgage however, rather than borrowing money from a bank or a lender to buy the real estate, the buyer makes payments to the real estate owner, or seller, until the purchase price is paid in full.
How does a Land Contract Work?
The buyer and seller negotiate the financial terms such as payment amounts, interest rate, and length of term, and practical terms such as who pays the taxes and insurance. At closing a Memorandum of Land Contract is recorded to give notice that equitable title has been conveyed to the Buyer. Equitable title is the right to the use and enjoyment of the property.
How do the payments work?
At the time of signing the purchase agreement, an earnest money deposit will be deposited with the escrow agent that will go toward closing costs and your down payment. When closing comes around you will bring the balance of the down payment and closing costs due. Your next outlay of cash will be your first month’s payment. Then you will make that same payment each month for the remainder of the land contract term. At the end of the land contract term, there may be a balloon payment due.
When you purchase on a land contract the term of the land contract is usually shorter than a traditional mortgage. You might see the term as 5, 7, or 10 years. When this happens the parties can lengthen the amortized terms if they choose for a longer term such as 15 or 30 years, which would result in more affordable payments during the early years of the land contract, however, you will end up with the balloon payment due at the end. If there is a balloon balance due at the end the buyer would need to either pay it off in full, renegotiate the term with the seller, refinance, or sell.
How does ownership work?
There are two types of title:
- Equitable Title: the right to the use and enjoyment of a property. The buyer will accumulate equity over time and is usually able to make any changes and improvements to the property.
- Legal Title: Actual property ownership. The legal title is transferred once the land contract is paid in full.
With a Land Contract the buyer holds equitable title while the seller retains legal title. Meaning as the buyer you will not receive full title at the closing table.
Why would you choose this type of financing option?
The number one benefit to Land Contracts is the flexible financing, which means less involvement from a financial institution. The seller controls the credit requirements, down payments, term, and interest rates. This can be helpful for those with lower credit scores, or self-employment incomes.
Let’s look at the Pros and Cons?
- Can make the property easier to sell
- May have potential tax advantages
- Regular cash flow for seller
- Seller collects Interest on land contract balance
- Buyer may need less up front cash
- Less closing costs required at closing
- Seller advantages in case of buyers non payment
- Legal title doesn’t pass right away to the buyer
- Issues if seller defaults on any underlying mortgage
- The buyer may have to depend on the seller
- May have a higher interest rate
Land Contracts are another option for buyers:
A land contract is always an option if you are struggling to receive financing. But it is important to speak with a Lender and receive all your options before you make a decision. At Vanguard, we are here to guide you! We know that buying or selling Real Estate is one of the most important and complex decisions you’ll make. We explain everything at the start of the closing process to minimize any confusion and prevent any surprises along the way. From beginning to end, we keep all parties involved in each transaction informed and updated. And we’re committed to making sure that your overall experience is a positive one. If you need lending and real estate professionals to determine your next steps, let us know, we have wonderful clients that can help you along the way.