If you’ve been exploring alternative financing to a mortgage, you might be wondering, what is a land contract? A land contract is a real estate transaction where the buyer and seller agree to an installment loan without the services of a bank, but with some recorded interest of the buyer in the property. The seller retains the title until the purchase amount is paid in full.
Land contracts are an alternative financing tool for buying property. If you’re up against a situation where your finances or your desired property don’t qualify for a traditional mortgage, you’ll want to take a closer look at whether or not a land contract makes sense. Land contracts, however, do have their limits.
In this article, we cover:
• What exactly is a land contract and how does a land contract work?
• Examples of how land contracts work
• How a land contract compares with a mortgage
• How to turn a land contract into a traditional mortgage
• Pros and cons of a land contract
• Alternatives to land contract financing
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What Is a Land Contract?
A land contract is a seller-financed real estate contract where the buyer makes installment payments until the full purchase price is paid. Once the buyer has paid in full, then the seller transfers the deed to the buyer. It’s comparable to a lease-to-own arrangement and is also known as a Installment Sales Contract, Agreement to Convey, and Agreement for Purchase and Sale. A land contract is not to be confused with a land loan, also known as a lot loan, which is used to purchase a plot of land. Nor is it the same as a real estate options contract, in which a buyer pays a premium to have the option to purchase a property during a specific window of time.
Land contracts are incredibly flexible, with the terms decided on by the buyer and seller. They’re often used when a buyer is unable to qualify for a traditional mortgage, the property does not meet lender requirements for a mortgage, or when the purchaser is buying a house from a family member.
Land contracts are usually set up with owner financing so the arrangement to pay the seller is temporary. It’s common to see a balloon payment at the end, with the expectation that the buyer will obtain traditional financing from other sources or pay off the loan entirely.
Land contracts can be risky for the buyer, and past uses of land contracts have been predatory. This is because the seller holds the title while the buyer is responsible for paying for the maintenance and repairs of the property. If the buyer gets behind on payments, the seller can demand the buyer vacate the property. If you are considering a land contract, it’s wise to also look into first-time homebuyer programs which might be another way to make ownership possible.
How Does a Land Contract Work?
With a land contract, the buyer receives what is called “equitable title” for the property. The buyer takes on many of the responsibilities of a homeowner, including paying for the upkeep and repairs of the property.
The city of Detroit, where there are more land contracts than traditional home mortgage loans, outlines four parts of the land contract.
Step 1: Research the home and review the contract
Some things you may want to look for before entering into a land contract include:
Ownership. Look for the name of the owner listed on official records (usually at your county clerk’s office). Prospective buyers have been duped into signing contracts with people who are not the property owners. (Getting a title report can help provide clarity.).
Liens and debts. Does the owner have any liens recorded against the property? Again, it’s likely you’ll need to check the county recorder’s office for this information.
Sales price. Is the sales price in line with what other properties of a similar size, age, and condition?
Condition of the home. Take into account what repairs need to be made and how much it will cost.
Review the contract: What deposit and installment amounts is the buyer expected to pay the seller? What are the other costs the buyer is responsible for? Are there any red flags in the language of the contract? It would be wise to hire a real estate attorney to review a land contract before signing.
Step 2: Sign the contract
Buyers can expect to bring payment and identification to signing. Forms you may be expected to fill out include: land contract, memorandum of land contract, property transfer affidavit, and principal residence exemption. Buyers will also want to read any disclosures the seller is required to provide, such as a lead disclosure.
Step 3: File contracts and uphold terms of the agreement
Be sure that the land contract is recorded. Obtain insurance and change utilities over to your name. Make sure you pay property taxes and make your scheduled installment payments.
Step 4: Exit the land contract
When the full amount is paid off — either with regular payments or by obtaining another mortgage — buyers will receive the deed to the property. Be sure to have the deed officially recorded and file a property transfer affidavit.
Land Contract Examples
Some examples of situations that might make a land contract a sensible alternative include:
• Buyer credit scores. Buyers with poor or no credit can sometimes find a path to homeownership through a land contract.
• Condition of the home. Homes that won’t pass inspection or meet lending guidelines will have trouble being financed with a traditional mortgage.
• Value of the home. Low-value homes may not be worth enough to qualify for a mortgage.
• Banks may view a community as high-risk. Some banks may not offer mortgages based on the location of the property.
Recommended: How to Make an Offer on a House
Land Contract vs Mortgage: How Do They Compare?
When you’re comparing a land contract with a mortgage, the key difference is who has ownership of the property. When a buyer secures a mortgage, the title of the property is transferred into their name. With a land contract, the title isn’t transferred to the buyer’s name until the purchase price is paid in full. There are other key differences, as outlined in the following comparison chart.
| Land Contract | Mortgage | |
|---|---|---|
| How the title is handled | Title conveyed when paid in full | Title conveyed when buyer secures a mortgage and closes |
| Foreclosure procedures | Seller can take back the property without going through the foreclosure process | Has legal foreclosure protections |
| How the buyer pays for the property | Buyer pays the seller directly | Buyer pays a lender |
| Who is involved in the contract | Contract made between buyer and seller | Contract involves a third-party lender |
| Closing costs | Avoids many closing costs | Has many closing costs |
| Who’s responsible for upkeep of the property? | Buyer | Buyer |
How to Turn a Land Contract Into a Traditional Mortgage
A land contract ends when it is paid in full. However, buyers don’t need to have paid the full amount to exit the land contract. Ideally, after a few years, the buyer is able to obtain a mortgage, pay off the land contract, and secure the title to the property. When the buyer pays on their own mortgage instead of paying a seller directly, they’ll have actual ownership and more legal protections. These are the steps buyers can follow to get a traditional mortgage following a land contract.
1. Improve your credit score if it is on the lower end
2. Build up your cash reserves and/or equity in the property
3. Get prequalified for a mortgage
4. Choose a lender, provide them with the land contract and installment history, and close on a loan
5. Pay off the land contract and receive the deed.
Pros and Cons of Land Contracts
Land contracts can be complicated, so it’s important to evaluate all the pros and cons of how it’s going to work.
Pros
• Land contracts are much more flexible than traditional mortgages
• Land contracts avoid large closing costs.
• Buyers can purchase properties that lenders are unwilling to underwrite.
• Fixer-uppers and low-priced homes can fall into this category.
• Buyers with low or no credit can purchase property with a land contract.
Cons
• Buyers can be taken advantage of by sellers in a land contract.
• The buyer has no control over the seller’s title.
• Situations, such as the death of the seller, can upend a land contract before title is conveyed.
• Buyers usually have to pay a higher interest rate on a shorter term, which could mean much higher payments than a traditional mortgage.
• Buyers do not have the legal protections of the foreclosure process and may lose all principal and installment payments made if they fail to meet the terms of the contract.
• The buyer may not be able to transfer the contract to another buyer should they change their mind and wish to exit the agreement.
Alternatives to a Land Contract
If you’re looking at buying property with a land contract, you’ve probably also come across these alternatives:
Owner financing. A land contract is a type of owner financing, but an owner can also help a buyer finance a home outright. With a land contract, the seller has more power to take back the property should the buyer miss payments. With owner financing, there may be a promissory note and mortgage recorded. (Owner financing is also known as a purchase-money mortgage.)
Lease with the option to purchase. With this type of contract, the buyer acts more like a renter and the seller as landlord. The buyer pays a fee to have the option to buy the property at the end of the lease period at a predetermined price.
Recommended: Can You Put an Offer on a Contingent House
The Takeaway
Land contracts have their place, but they also have limitations. When you’re ready to switch over to a traditional mortgage, you can have full interest in the property, meaning, the property is titled in your name and there are more legal protections on your side when it comes to foreclosure.
Looking for an affordable option for a home mortgage loan? SoFi can help: We offer low down payments (as little as 3% - 5%*) with our competitive and flexible home mortgage loans. Plus, applying is extra convenient: It's online, with access to one-on-one help.
FAQ
What is the main disadvantage of a land contract to the seller?
Sellers may need to take on the role of landlord since the financing to the buyer bypasses a lender. They also delay getting paid in full for the property.
What is the interest rate on a land contract in Michigan?
As per state law, the maximum interest rate that can be charged on a land contract in Michigan is 11%.
Does a land contract have to be recorded in Indiana?
To be valid in Indiana, a land contract must be recorded with the county recorder. If it’s not recorded, the contract isn’t enforceable and disputes are difficult to resolve in court.
Photo credit: iStock/skynesher
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