First-time buyer - What's a land contract?

Written by Posted On Friday, 18 April 2014 09:13

 

Question - I saw a listing that said the seller would accept a land contract. What’s that all about and should I look at that option?

Answer - That’s a form of sale that isn’t used a lot these days, but is still an option for sellers and buyers. Think of a land contract as a sale where the seller is also acting as the bank or mortgage lender. Basically the seller has offered to extend a loan to the buyer, just like a mortgage, and act just like the bank might – charging interest and collecting the payments – with the title to the property held in escrow as the collateral for the loan. Land contracts are normally set up as shorter term balloon loans with the balance coming due in 3 to 5 years (sometimes longer). During the term of the land contract the buyer has the right to occupy the property and most of the rights and privileges that come with ownership, however,  the seller retains the title to the property (sort of like the fact that the mortgage company has the first claim to the title of you fail to pay on a mortgage), which is normally held in escrow by a title company. For all intents and purposes you will appear to be the owner of the property, including the privilege of paying the property taxes.

How does this all work?

Well, there is a contract (the Land Contract) signed by you and the seller. That contract defines the terms and conditions of the sale – the down payment required, the interest rate to be charged and the term of the contract, plus the provisions for what happens if the buyer fails to perform and make payments. There may also be restrictions enumerated in the Land Contract about what the buyer can and cannot do to the property until such time as the contract is fulfilled and the title passed. Those provisions give the seller some insurance against you doing something to the place that would decrease its value.

The buyers are required to have insurance coverage that is satisfactory to the seller, too; which is again to protect the seller’s interest in case the place got destroyed somehow. You can expect that there will be provisions for having to prove to the seller that you are keeping up the insurance payments and any tax payments that are levied against the property. The seller doesn’t want have a tax lien placed against the property or to see it burn down with no insurance coverage.

What else should know about Land Contracts?

For one, they are usually more expensive in terms of the “mortgage rate” than a real mortgage. That is because the seller is building some risk factor into the rate. Rates in Land contracts can be whatever the seller wishes to charge and whatever he can get. People who go into Land Contracts often don’t have the best credit histories, so they usually have to pay a premium to get the seller to finance them. Expect to pay two or more points on a Land Contract vs. what you could get from a mortgage company. Basically the seller can charge whatever they can get, so long as they don’t run afoul of the states usury laws.

You can also expect to have to put down 20% or more. The “down stroke” as it is often called gives the seller a financial pad in case you fail to perform and he has to foreclose on the contract. It is also used to pay commissions if Realtors® are involved in the sale. The “loan” is actually amortized out usually on a 20 or 30 year basis to arrive at the monthly payment, with that big balloon payment sitting out there at the end of the 3-5 year period of the contract. In that short a period you will not have paid down the original principal on the loan very much.

Why do people do Land Contracts?

Well, I already mentioned that most people who get into land contracts have had some credit issues in the past. Many people who lost a home to foreclosure or a short sale sought Land Contracts because they could not qualify for any regular form of mortgage financing. Some people found themselves homeless but still had good jobs (or got a good job after going through foreclosure) and perhaps a source that they could tap to put together a down payment. For them a Land Contract was the best (perhaps the only) way to buy a new home. The buyer is usually betting on the come that his credit rating will be good enough at the end of the balloon period to get a regular mortgage at a better rate.

As for the seller’s motivation; usually they can get a premium price and well as a premium rate because the people looking for Land Contracts have little choice but to pay extra as a consequence of their bad credit history. The seller usually doesn’t have to worry about an appraisal either, since he is selling at the price that he has set, whether the appraisal value is there or not.

Would I need a lawyer or title company?

Remember that the Land Contract is just that – a contract – and anytime you get involved with contracts that involve obligations this large it is good practice to seek legal counsel. At least you should have a lawyer look over the contract ad advise you about it. A title company is usually involved to handle filing the paperwork to record the contract at the County Recorder of Deeds office and perhaps to hold the title in escrow.

So, is a Land Contract right for me?

I can’t answer that for you. If you have bad credit, it may be your only option; however, if you have decent credit and the wherewithal to make a down payment and cover closing costs, then I see no reason why you would want to consider doing a Land Contract. Any property that has a land contract option is usually also for sale with a regular mortgage – try that first.

 

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Norm Werner

Norm Werner is a Realtor at the Milford office of Real Estate One serving the southeastern Michigan area of Oakland and Livingston Counties. Norm specializes in residential real estate. Norm lives and works in Milford Michigan and is married to Carolyn Werner. Norm and Carolyn live in a historic home just three blocks from downtown Milford, with their two dogs - Sadie and Skippy. Norm specializes in the historic homes of Milford and the surrounding area and is on the Board of Directors of the Milford Historical Society. Norm especially enjoys working with first time buyers and those at the other end of the real estate spectrum who are downsizing into their retirement home. 

In addition to his Movetomilford.com web site, Norm also owns and m,aintains TheMilfordTeam.com web site, the HuronValleyRealtor.com web site. He is also the webmaster for and the MilfordHistory.org web site and the MilfordCar Show.com web site, as well as his church web site - Spiritdrivenchurch.com. In addition to blogging about real eastate, Norm has a personal blog - NormsMilfordBlog.com - on which he shares inspirational messages and the occasions personal observation about life. 

www.movetomilford.com

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