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What is a Land Contract and How Does It Work?

A land contract is a real estate transaction in which a buyer finances a property by making installment payments to the seller. The buyer gains access to the home, but the seller maintains the legal title until the buyer pays off the loan.

What is a land contract?

Land contracts are a form of owner financing. They’re also called contracts for deed or installment sale contracts. With a land sale contract, a buyer purchases a property by making payments to the seller for a specific term. Land contracts give buyers who have less-than-stellar credit an alternative to a traditional mortgage.

When a buyer and seller initiate a contract for deed, the buyer takes possession of the home and has equitable title to the property — meaning they have a vested interest in the home. However, the seller retains legal title to the property until the buyer pays off the loan.

A buyer who fails to meet the terms of an installment contract forfeits their rights to the property as well as to any payments made. The seller can also take back legal possession of the home or land through a forfeiture process or, in some states, foreclosure. Contracts for deed can be made for multiple types of real estate sales, including land-only purchases, single-family homes, multifamily homes and some condos.

How does a land contract work?

The process of buying owner-financed land differs slightly from a traditional home purchase. Buyers should approach purchasing land contract real estate like they would any new home purchase, said Scott Royal Smith, an Austin, Texas-based real estate attorney and founder and CEO of Royal Legal Solutions. Here’s a step-by-step overview of how a land contract works.

  1. Identify a land contract home. Buyers may find these homes through real estate agents, listings or through third-party services that specialize in land contract homes.
  2. Negotiate the terms of the land-purchase agreement. The buyer and seller agree to the terms of the contract for deed, including, but not limited to, the purchase price, interest rate, loan term, installment amount and down payment — if any.
  3. Arrange an inspection. Buyers should arrange for a full home inspection. Similarly, buyers may choose to do an appraisal. However, Smith suggested that buyers avoid the cost of an appraisal by getting a broker’s price opinion (BPO) instead.
  4. Sign the land contract. Once both parties agree to the final terms, they move forward with the agreement, and the buyer makes the down payment, if applicable. The land contract will include a clause that states the title of the property will transfer to the buyer after the loan is fully repaid. The buyer’s equitable title begins as soon as a contract for deed is signed.
  5. Move into the home. In most cases, the buyer takes possession of the property after the installment agreement is signed.
  6. Record the land contract. Contract for deed agreements are typically registered with the county in which the property is purchased, although not every state requires this.
  7. Begin making installment payments. The buyer makes payments either directly to the seller or a servicing company. Failing to make payments or meet other contract terms means the buyer forfeits their rights to the property. The owner can begin the forfeiture process, too.
  8. Pay off the loan. The buyer gains full title to the property after repaying the loan in full or refinancing it.

What to look for in a land contract agreement

  • Complete payment terms. A land contract should spell out the purchase price, down payment, payment schedule, installment amount, interest rate, loan term and balloon payment amount, if applicable.
  • Responsible party for home repairs. The buyer and seller agree upfront on who will make and pay for home repairs.
  • Responsible party for paying property taxes and homeowners insurance. The buyer and seller decide who will pay annual property taxes and homeowners insurance premiums. Regardless of who makes the payments, the cost of taxes and insurance is usually included in the installment payment.
  • Default procedure. An installment contract will spell out what constitutes default, the penalties involved, the buyer’s options for bringing the loan current and the seller’s options if the buyer defaults.
  • Additional provisions. A land contract spells out when the buyer gains legal title, their ability to make changes to the property and whether they can transfer their interest in the property to another party without notifying the seller.

Land contract terms and interest rates

Land contract terms can vary greatly, from one or two years up to 30-year terms like traditional mortgages. Short-term land contracts, though, are more common, Smith said. Ultimately, the seller and buyer agree on the contract length. For example, both parties might settle on a five-year land contract with a balloon payment at the end.

Even with shorter contracts, buyers are likely to refinance before the contract ends. “It almost never happens that somebody stays in the note and pays it off to completion,” Smith said, adding that buyers usually remain in these agreements for about two years at most. “They usually only stay long enough to be able to repair their credit and refinance.”

Interest rates on land contracts can vary dramatically, and buyers and sellers ultimately call the shots on the loan’s rate. That said, interest rates typically stay under 12%, Smith said.

Federal loan regulations, as well as state usury laws, restrict sellers from overcharging interest fees. The interest rate limit sometimes depends on the home’s purchase price and the number of owner-financed land transactions a seller is involved in at a given time.

How to calculate interest rates on a land contract

Depending on the terms of the agreement, the installments may be interest-only. Sometimes, the payments might include the principal amount.

To calculate the interest payment, 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.

This example applies to an interest-only payment. If a payment includes principal, the interest portion of the installment payment will decrease as the loan progresses and will be different for each payment.

Pros and cons of buying a land contract home

Pros Cons
  • 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 less restrictive for buyers
  • Closing costs are lower
  • Less time to close
  • Higher purchase price and interest rate than a traditional purchase agreement
  • Forfeit rights to the property and monies paid 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
  • Legal title is withheld until the loan is completely paid off

 

 

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