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How and when to use land contracts to buy a home


Land contracts are a source of seller financing generally used for unique property types and situations. Instead of borrowing from a mortgage lender, you make payments to the seller of the property you’re buying. So, what do you need to know if you want to use a land contract to buy a home? And what are the steps to refinance out of one?

In this blog, we’ll cover:

  • What is a land contract?

  • When should I use a land contract to buy a home?

  • How do payments work with a land contract?

  • What are the risks of a land contract?

  • Recorded vs Unrecorded land contacts.

  • How to use a land contract for a home purchase.

  • How to refinance out of a land contract.

  • How we can help.

 

What is a land contract?


A land contract is a written agreement for a private loan between a home buyer and seller for the purchase of land or property. The seller will provide financing (as the lender) and they will, in turn, allow the buyer to move into the property under the terms of their agreement as they work towards eventual ownership by paying off the land contract.
You can learn about the different types of land contracts here.

Not long ago, land contracts were extremely popular when mortgages were difficult to qualify for and had extraordinarily high-interest rates. Although they have decreased in popularity, land contracts as a source of seller financing remain common in areas of the country with unique properties or high self-employment.Like many older lending programs, land contracts serve a niche audience as most home buyers will find greater benefit and security from a traditional mortgage product.

Like many older lending programs, land contracts serve a niche audience as most home buyers will find greater benefit and security from a traditional mortgage product.

 

When should I use a land contract to buy a home?


With a land contract, you’re negotiating the purchase, lease, and terms of your living situation directly with your lender (the seller). This provides you a benefit since the seller has a vested interested in making sure you are able to successfully buy their property.

The main reason people move forward with a land contract for seller financing is for the easier qualification. Qualifying is significantly easier for a land contract since your seller won’t have the same regulations, guidelines, or fees associated with a bank or mortgage lender. With that in mind, read your contract carefully. There is a reason why qualifying for a mortgage is an involved and regulated process. When you make this easier, you increase the risk for both the buyer and the seller.

Here are a few specific scenarios when a land contract could be an advantage for you:

  • Buying a home as a non-U.S. citizen (foreign nationals): A home buyer who is not a U.S. citizen may have trouble getting a loan in the U.S. Although there are programs allowing for them to become homeowners, they can be difficult to find and qualify for. A land contract would be easier to qualify for and make the barrier to homeownership more surmountable.

  • Purchasing a unique property: If your new home doesn’t have any comparable properties and you need financing to secure it, a land contract may be your only option. Keep in mind, selling this property later will be just as difficult for you. You may need to seller finance to your future buyer as well.

  • Recent divorce or bankruptcy causing major credit issues: Buyers with a troubled credit history may find it easier to purchase with a land contract, but no two sellers are the same. As they don’t adhere to the same guidelines and requirements of a mortgage lender, this will also be part of your negotiations to purchase. 

Unless you know for certain you won’t qualify for a mortgage, it is in your best interest to obtain a traditional mortgage product instead of a land contract since they can get tricky down the road.

 

How do payments work with a land contract?


When you have a land contract, the buyer will typically make payments directly to the seller, and the seller will disburse this payment towards all interested parties for the property. Generally, this will be any mortgage/lien on the property, property taxes, and the seller’s profit from the contract. For some buyers, this can be convenient since their payment arrangement will stay the same year-to-year, and they won’t have to deal with a bank for sending in their payments. 

Land contracts are typically amortized (payment schedule) over 30 years with a five-year balloon payment (remaining loan balance becomes due immediately). While not beneficial for most, this can be extraordinarily useful for someone with limited time in a high-income field, such as owner-operators (truck drivers), commission fields, and self-employment. Over the five years of their land contract, they can have a stable home and work towards qualifying for a traditional mortgage to pay off their balloon payment at the end of the five years.

 

What are the risks of land contracts?


While land contracts are more lenient in their requirements for a buyer, they aren’t always in your best interest. The guidelines and regulations that dictate how a mortgage lender determines whether or not you’re qualified work to your benefit, because lenders determine the likelihood of your ability to repay the loan. With that in mind, here are a few reasons why you may want to reconsider moving forward with a land contract:

  • Your income isn’t verified: Typically, sellers will not verify your income with a land contract the same way a mortgage company does, or even review your credit to determine your liabilities. This means you may find yourself “approved” by the seller to purchase the property, but you could find yourself struggling to make payments shortly after. 

  • Balloon payments can be dangerous: These are common with land contracts - it’s just a term to say that your remaining debt is due in full immediately. This will commonly happen at the end of your land contract term (typically five years with payments amortized over 30 years) or if you miss payments. If you needed the land contract originally and not much has changed since then, you could quickly find yourself homeless and out thousands of dollars in down payment and monthly payments that could otherwise have gone towards savings for a mortgage or investing in a property you actually own. 

  • You likely don’t own the property: Do you know if the title is recorded in your name? Do you know who owns the home with your contract? More often than not, the seller retains title and ownership over the property until you’ve paid off the land contract - either through your own funds or through a purchase transaction to buy out the contract. In the likely scenario that you are not the owner, this means you also do not have the rights of an owner. The seller may evict you for a number of reasons, and if the seller fails to pay their mortgage or taxes for the property, you may be evicted. You’re in a rent-to-own situation with none of the luxuries afforded to homeowners. 

  • You have to handle maintenance: Unfortunately, you do have the burdens of a homeowner since you need to maintain the property. Read your contract carefully. Who is responsible for appliances? Who’s responsible for the property? In most cases, it’s probably you. 

  • Contracts can be tricky: We had a potential home buyer in a land contract who wanted to refinance his property after living in his home for five years. Unfortunately, he discovered he did not own the home after he came to us, and we reviewed the contract with him. In the end, we had to refer him to a real estate attorney for advice on how to proceed. 

 

Recorded vs Unrecorded land contracts - important information to know.


One of the most common issues with land contracts is they are rarely recorded. When a land contract is not recorded, there is no record of the transaction and details to verify your potential ownership in the property. This relates to the above point that you likely don’t own the property you’ve paid thousands of dollars for. Additionally, when the property is not recorded, you
cannot refinance it, you must purchase the property. The important difference here is you’ll need a new down payment to purchase the property when your land contract balloon payment comes due. That is a lot of extra cash to suddenly have available.

For example, let’s say you purchased a $200,000 home with a land contract. The seller required 10% down, and you paid another $30,000 in principal over the last few years. You now owe $150,000 to the seller that must be paid in full. Naturally, you go to refinance your property to get the remaining balance flipped to you since you’ve got about $50,000 in equity. Right? The answer is…maybe.

If the deed was recorded, and your seller kept your payments in a separate account over the course of your contract, then yes. You’ll be able to refinance with no serious problems, assuming you qualify for the mortgage. If the deed was unrecorded, you’ll need to make a new down payment on the $150,000 and pay closing fees associated with a purchase. Basically, you’re buying the house twice since the first time technically didn’t happen. You just gave someone a lot of money for rent.

And what about the title/deed? Do you know where it is and do you have a contingency in place if something happens to the seller? These are the answers you need to know if you ever want to formally become the owner of the house. We recommend recording the deed as soon as possible, otherwise, it may be difficult to prove that the deed was rightfully transferred to you. This will also be a requirement of any lender if you’ll need a mortgage on the property. 

In addition, failure to record your deed can have a number of problems with state and federal taxes. You must check your state’s regulations regarding penalties for failing to record your deed. There may be additional fees due to being late. If your contract isn’t strong enough, you may lose the property if something should happen to your seller before formal transfer. Just because you live there doesn’t mean you own it.

Read your contract, know your agreement.

 

How to use a land contract for a home purchase.


1. Talk to an expert
first - As you’ve learned, land contracts can be very complicated. If you are looking to buy a property with a land contract, we suggest you reach out to one of our Loan Officers or give us a quick call at 855-610-1112 to discuss your scenario. A land contract should not be your first choice, take the time to see if you have other options. 

2. Hire a real estate attorney - If you’re certain a land contract is the best choice for you, find and hire a real estate attorney. Without a proper contract, you could get the raw end of the deal down the line. Items such as the title and property responsibilities need to be crystal clear. An attorney will also be able to provide expertise during your negotiations. 

3. Negotiate the contract - There are several types of land contracts you may choose to use - straight contracts, all-inclusive (wrap-around) contracts, and installment sale contracts. All the details will be finalized here, and that’s why it’s important for both parties to have an attorney. 

4. Get your finances in order - The contract is completely based on your negotiations with the seller. Although you won’t be up to the same standards as a regulated loan, you’ll want to have proof of income and cash in the bank to cover the down payment. They will likely also pull your credit report.

5. Get an appraisal and title insurance - An appraisal will provide you an accurate value of the property. These cost around $500. Assuming the title is transferred to your name, get title insurance to protect both you and the seller. 

6. Close on the deal - Since there isn’t a lender involved, you could close very quickly. You will have already decided how you are handing off the down payment and any additional fees required by the seller. Once everything is signed, make sure to maintain copies of all documents.

 

How do I refinance out of a land contract?


If you are looking to
refinance out of a land contract (a private loan), talk to our experts before your loan balance inevitably is due. We will be able to identify any red flags early. The seller of the property will need to be heavily involved. At the bare minimum, the seller will need to provide the following: 

  • A notarized title with a signed release of the lein.

  • A non-mortgage related payoff.

  • Proof of verification of a land contract.

  • Proof of addresses for both parties as well as contact information.

  • Copy of the seller’s original warranty deed.

Whether you’re a buyer or seller of the property, getting help early will save you tons of headaches.

 

How we can help.


We are always here to make sure you’re getting the best deal on your mortgage. In most cases, our customers
qualify for a mortgage and can avoid the uncertainty of a land contract. And if you’re refinancing, we can help you get your documentation in order. For the fastest answer, give us a call at 855-610-1112.

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