Josh Sanders, Founder of Shiloh Street
Using a land contract when buying or selling a home can have its advantages and disadvantages, depending on the real estate situation you’re in.
Land contracts (also called installment contracts and contracts for deed) were used more frequently 30-40 years ago when mortgage interest rates were in the teens and it was harder to qualify for a home loan.
While mortgage rates are near historic lows today, land contracts can still be used to benefit buyers and sellers in certain real estate transactions.
Definition:
A land contract is used to convey real estate to another party without passing legal ownership of the property; only the right of possession.
It’s used as a contract between a buyer and seller where the seller acts as a lender for the buyer by providing ‘owner-financing’. The buyer makes installment payments to the seller for an agreed upon term, which frequently ends with a lump sum balloon payment.
When the final installment payment is made to the seller, legal title and ownership of the property then passes from the seller to the buyer. Until that point, the buyer only has a legal right to possess the property.
Use it to Buy Real Estate?
As a home buyer, buying real estate on a land contract can be a great option if you can’t qualify for conventional financing. You’re able to purchase the property now while you fix your bad credit and then qualify for a conventional mortgage within 1-3 years, at which point you could payoff the seller and obtain legal title and ownership of the property.
The advantage as a buyer is that you’re able to purchase the property and begin making payments to the seller while you’re repairing your credit. It can be a much better option compared to renting or waiting until your credit score is high enough to qualify for conventional financing.
Finding a seller to offer this type of ‘owner-financing’ may not be easy to find but it’s possible and worth the effort if you can find a bargain. Looking for real estate being sold ‘for sale by owner’ is a perfect place to start your search for these kinds of sellers.
You’ll want to negotiate financing terms with the seller that you can keep. You can negotiate interest-only payments, a very short-term with a large balloon payment, a long-term with a smaller balloon payment and/or an interest above or below the current mortgage rates.
You have many options and all the terms are negotiable so make sure the numbers fit into your current budget as well as where you think you’ll be financially in the near future. (be sure to read our ‘First Time Home Buyer Guide‘ for more tips)
Selling Your Property
As a seller, you may be able to sell your property at a higher sales price and attract more home buyers while still retaining legal ownership of the property.
By acting as the bank and offering ‘owner-financing’, you can attract a larger number of home buyers who can’t qualify for a conventional home loan but who may be able to make the required monthly payments.
In return for providing the financing for the buyer, you can negotiate a higher sales price and a shorter installment payment period. This would allow you to earn more profit from the sale of your property and ‘cash out’ quicker once the buyer is able to qualify for a conventional mortgage.
Skip the Closing Costs
One advantage to both parties is that the typical closing costs associated with conventional financing, aren’t required with a land contract. This can save the buyer and seller a substantial amount of money compared to using a conventional 3rd party lender and escrow company.
For example, most lenders require a real estate appraisal to be completed to secure financing. The buyer usually pays this cost but it may not be necessary with a land contract if the buyer feels comfortable with the local real estate values and purchase price (I might still obtain a real estate appraisal for my own peace of mind but it’s nice to have that choice).
There may be some standard closing costs that both parties would indeed prefer to pay for such as document recording, pest inspection or credit report verification of the buyer. The great thing is that these items can be negotiated between the home buyer and seller rather than required by a 3rd party lender.
Owner-Financing Details
With land contracts being used as a type of ‘owner-financing’, the financing terms can be negotiated between the buyer and seller. In most cases, the terms will look more like short-term financing rather than long-term, conventional mortgages.
Commonly, a balloon payment will be due from the buyer years before the financing would fully amortize. That’s when the buyer will try to obtain a conventional mortgage and secure long-term financing to purchase the property and transfer full ownership rights (if they don’t have the cash laying around to do so).
A Real Estate Investing Tool?
Land contracts are popular among real estate investors too since they allow them to do some creative real estate deals. Real estate investors can put very little money down and in some cases, assign the contract to another buyer and earn a fee.
A common use in real estate investing is ‘wrap around financing’ where the seller has one or two mortgages on the property. The buyer and seller can draw up a land contract, which keeps the current mortgage(s) in place but transfers possession rights and future legal title to the buyer. This is common when the property is difficult to sell due to its condition or location or when the seller is eager to move. In most cases, this won’t trigger the current mortgage’s ‘due on sale clause’, which is the main reason for this ‘wrap around financing’ technique.
No matter what real estate situation you use a land contract for, be sure to talk with a real estate attorney to make sure your bases are covered. When real estate transactions don’t have 3rd parties involved (such as a Shiloh Street agent) to negotiate the terms, details can be overlooked and you don’t want to get yourself in a legal battle!
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