Land contract
Encyclopedia
A 'land contract' is a contract between a seller and buyer of real property
in which the seller provides financing to buy the property for an agreed-upon purchase price and the buyer repays the loan
in installments. Under a land contract, the seller retains the legal title
to the property, while permitting the buyer to take possession of it for most purposes other than legal ownership. The sale price is typically paid in periodic installments, often with a balloon payment
at the end to make the timelength of payments shorter than a corresponding fully amortized
loan without a final balloon payment. When the full purchase price has been paid including any interest
, the seller is obligated to convey legal title to the property to the buyer. An initial down payment
from the buyer to the seller is usually also required by a land contract. The legal status of land contracts varies from region to region.
Since a land contract specifies the sale of a specific item of real estate
between a seller and buyer, a land contract can be considered a special type of real estate contract
. In the usual, more conventional real estate contracts, a seller does not provide a loan to the buyer; the contract either does not specify a loan or includes provisions for a loan from a different "third party" lender, usually a financial institution in practice. When third party lenders are involved, typically a lien
called a mortgage or trust deed
is placed on the property so that the value of the property is used as collateral until the loan is paid in full.
. In effect, each installment payment is partially payment of the purchase price and partially payment of interest on the unpaid purchase price. This is similar to mortgage payments which are part repayment of the principal amount of the mortgage loan and part interest. As the buyer pays off more of the principal of the loan, his(her) equitable title or interest in the property increases. For example, if a buyer pays a $2000 down payment and loans $8000 for a $10000 parcel of land, and pays off in installments another $4000 of this loan (not including interest), the buyer has $6000 of equity in the land or 60% of the equitable title, but the seller holds legal title to the land as recorded in documentation (deed
s) in a government recorder's office
until the loan is completely paid off. However, if the buyer defaults on installment payments, the land contract may consider the failure to timely pay installments a breach of contract
and the land equity may revert to the seller, depending on the land contract provisions.
Since land contracts can easily be written or modified by any seller or buyer; one may come across any variety of repayment plans. Interest only, negative amortization
s, short balloons, extremely long amortizations just to name a few. It is not uncommon for land contracts to go unrecorded. For several reasons, the buyer or seller may decide that the contract is not to be recorded in the register of deeds. This does not make the contract invalid, but it does increase exposure to undesirable side effects. Some states, such as Minnesota, issue contracts without an acceleration clause
, which in the case of a default leaves the seller in a position to either cancel the contract, discharging any principal deficiency, as in the case of deprecation, or to litigate for 18 months or more while letting the buyer, if not a corporation, retain their rights to the property while collection attempts are made, by which time the buyer will often qualify for bankruptcy, making the contract, when lacking said acceleration clause
, effectively an installment option, when the buyer has no other lienable assets. In bankruptcy, some regions will interpret it as an executory contract
than can be rejected, while others will treat it as a debt to be paid out of the bankruptcy trust. This and a wide variety of other legal ambiguities has led to a trend toward restatement as mortgages to eliminate any incentives to not simply use the more clarified in law note and mortgage.
. Since the amount of the final payment is so large, the buyer may obtain a conventional mortgage loan from a bank to make the final payment. Land contracts are sometimes used by buyers who do not qualify for conventional mortgage loans offered by a traditional lending institution, for reasons of unestablished or poor credit or an insufficient down payment. Land contracts are also used when the seller is anxious to sell and the buyer is not given enough time to arrange for conventional financing.
There can be other advantages of using a land contract too. When a third party lender, such as a financial institution, provides a loan, this third party has its own interests to protect against the other two parties involved, the seller and buyer. Establishing the correct title and value of the property to be used as collateral is important to the lender. Thus, the lender commonly requires title service including title search and title insurance
by an independent title company, appraisal
and termite inspection of the property to ensure it has sufficient value, a land survey
to ensure there are no encroachments, and use of lawyers to ensure the closing
is done correctly. These third party lender requirements add to closing costs which the lender requires the seller and/or buyer to pay. If the seller is also the lender, these costs are usually not required by the seller and may result in closing cost savings and fewer complications. It may also be the seller's position that if the buyer requires any of these services, he could pay for the costs and make arrangements himself. For properties where only relatively undeveloped land is involved and if the seller is willing to finance, the price of the empty land may be so low that the conventional closing costs are not worthwhile and can be an impediment to a quick, simple sale. Easy financing and a simple sale transaction may be a good selling point for a seller to offer a buyer.
The land contract may also allow the buyer to assign his equitable title/interest in the property to yet another buyer even before the loan is paid in full, subject to conditions in the land contract, effectively reselling his equity in the property to the new buyer.
Real property
In English Common Law, real property, real estate, realty, or immovable property is any subset of land that has been legally defined and the improvements to it made by human efforts: any buildings, machinery, wells, dams, ponds, mines, canals, roads, various property rights, and so forth...
in which the seller provides financing to buy the property for an agreed-upon purchase price and the buyer repays the loan
Loan
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....
in installments. Under a land contract, the seller retains the legal title
Title
A title is a prefix or suffix added to someone's name to signify either veneration, an official position or a professional or academic qualification. In some languages, titles may even be inserted between a first and last name...
to the property, while permitting the buyer to take possession of it for most purposes other than legal ownership. The sale price is typically paid in periodic installments, often with a balloon payment
Balloon payment
When a debt is repaid in payments of varying amounts there are some colourful jargon terms used to describe the different loan structures. The term balloon payment arises because if you hold back most of a debt and pay it only towards the end of the agreement, both those last payments and the total...
at the end to make the timelength of payments shorter than a corresponding fully amortized
Amortization
Amortization is the process of decreasing, or accounting for, an amount over a period. The word comes from Middle English amortisen to kill, alienate in mortmain, from Anglo-French amorteser, alteration of amortir, from Vulgar Latin admortire to kill, from Latin ad- + mort-, mors death.When used...
loan without a final balloon payment. When the full purchase price has been paid including any interest
Interest
Interest is a fee paid by a borrower of assets to the owner as a form of compensation for the use of the assets. It is most commonly the price paid for the use of borrowed money, or money earned by deposited funds....
, the seller is obligated to convey legal title to the property to the buyer. An initial down payment
Down payment
Down payment is a payment used in the context of the purchase of expensive items such as a car and a house, whereby the payment is the initial upfront portion of the total amount due and it is usually given in cash at the time of finalizing the transaction.A loan is then required to make the full...
from the buyer to the seller is usually also required by a land contract. The legal status of land contracts varies from region to region.
Since a land contract specifies the sale of a specific item of real estate
Real estate
In general use, esp. North American, 'real estate' is taken to mean "Property consisting of land and the buildings on it, along with its natural resources such as crops, minerals, or water; immovable property of this nature; an interest vested in this; an item of real property; buildings or...
between a seller and buyer, a land contract can be considered a special type of real estate contract
Real estate contract
A real estate contract is a contract for the purchase/sale, exchange, or other conveyance of real estate between parties. Real estate called leasehold estate is actually a rental of real property such as an apartment, and leases cover such rentals since they typically do not result in recordable...
. In the usual, more conventional real estate contracts, a seller does not provide a loan to the buyer; the contract either does not specify a loan or includes provisions for a loan from a different "third party" lender, usually a financial institution in practice. When third party lenders are involved, typically a lien
Lien
In law, a lien is a form of security interest granted over an item of property to secure the payment of a debt or performance of some other obligation...
called a mortgage or trust deed
Trust deed
Deed of trust may refer to:* Trust deed * Trust instrument, a legal instrument in common law systems* Trust Deed , used in Scottish law* Deed of Trust , music album...
is placed on the property so that the value of the property is used as collateral until the loan is paid in full.
Installment payments
It is common for the installment payments of the purchase price to be similar to mortgage payments in amount and effect. The amount is often determined according to a mortgage amortization scheduleAmortization schedule
An amortization schedule is a table detailing each periodic payment on an amortizing loan , as generated by an amortization calculator. Amortization refers to the process of paying off a debt over time through regular payments...
. In effect, each installment payment is partially payment of the purchase price and partially payment of interest on the unpaid purchase price. This is similar to mortgage payments which are part repayment of the principal amount of the mortgage loan and part interest. As the buyer pays off more of the principal of the loan, his(her) equitable title or interest in the property increases. For example, if a buyer pays a $2000 down payment and loans $8000 for a $10000 parcel of land, and pays off in installments another $4000 of this loan (not including interest), the buyer has $6000 of equity in the land or 60% of the equitable title, but the seller holds legal title to the land as recorded in documentation (deed
Deed
A deed is any legal instrument in writing which passes, or affirms or confirms something which passes, an interest, right, or property and that is signed, attested, delivered, and in some jurisdictions sealed...
s) in a government recorder's office
Recorder of deeds
Recorder of deeds is a government office tasked with maintaining public records and documents, especially records relating to real estate ownership that provide persons other than the owner of a property with real rights over that property.-Background:...
until the loan is completely paid off. However, if the buyer defaults on installment payments, the land contract may consider the failure to timely pay installments a breach of contract
Breach of contract
Breach of contract is a legal cause of action in which a binding agreement or bargained-for exchange is not honored by one or more of the parties to the contract by non-performance or interference with the other party's performance....
and the land equity may revert to the seller, depending on the land contract provisions.
Since land contracts can easily be written or modified by any seller or buyer; one may come across any variety of repayment plans. Interest only, negative amortization
Negative amortization
In finance, negative amortization, also known as NegAm, deferred interest or graduated payment mortgage, occurs whenever the loan payment for any period is less than the interest charged over that period so that the outstanding balance of the loan increases...
s, short balloons, extremely long amortizations just to name a few. It is not uncommon for land contracts to go unrecorded. For several reasons, the buyer or seller may decide that the contract is not to be recorded in the register of deeds. This does not make the contract invalid, but it does increase exposure to undesirable side effects. Some states, such as Minnesota, issue contracts without an acceleration clause
Acceleration clause
An acceleration clause, in the law of contracts, is a term that fully matures the performance due from a party upon a breach of the contract. Such clauses are most prevalent in mortgages and similar contracts to purchase real estate in installments....
, which in the case of a default leaves the seller in a position to either cancel the contract, discharging any principal deficiency, as in the case of deprecation, or to litigate for 18 months or more while letting the buyer, if not a corporation, retain their rights to the property while collection attempts are made, by which time the buyer will often qualify for bankruptcy, making the contract, when lacking said acceleration clause
Acceleration clause
An acceleration clause, in the law of contracts, is a term that fully matures the performance due from a party upon a breach of the contract. Such clauses are most prevalent in mortgages and similar contracts to purchase real estate in installments....
, effectively an installment option, when the buyer has no other lienable assets. In bankruptcy, some regions will interpret it as an executory contract
Executory contract
An executory contract is a contract which has not yet been performed or executed. Although material, an obligation to pay money does not usually make a contract executory. An obligation is material if a breach of contract would result from the failure to satisfy the obligation...
than can be rejected, while others will treat it as a debt to be paid out of the bankruptcy trust. This and a wide variety of other legal ambiguities has led to a trend toward restatement as mortgages to eliminate any incentives to not simply use the more clarified in law note and mortgage.
Reasons for a land contract
Although most land contracts can be used for a variety of reasons, their most common use is as a form of short-term seller financing. Usually, but not always, the date on which the full amount of the purchase price is due will be years sooner than when the purchase price would be paid in full according to the amortization schedule. This results in the final payment being a large balloon paymentBalloon payment
When a debt is repaid in payments of varying amounts there are some colourful jargon terms used to describe the different loan structures. The term balloon payment arises because if you hold back most of a debt and pay it only towards the end of the agreement, both those last payments and the total...
. Since the amount of the final payment is so large, the buyer may obtain a conventional mortgage loan from a bank to make the final payment. Land contracts are sometimes used by buyers who do not qualify for conventional mortgage loans offered by a traditional lending institution, for reasons of unestablished or poor credit or an insufficient down payment. Land contracts are also used when the seller is anxious to sell and the buyer is not given enough time to arrange for conventional financing.
There can be other advantages of using a land contract too. When a third party lender, such as a financial institution, provides a loan, this third party has its own interests to protect against the other two parties involved, the seller and buyer. Establishing the correct title and value of the property to be used as collateral is important to the lender. Thus, the lender commonly requires title service including title search and title insurance
Title insurance
Title insurance is a form of indemnity insurance predominantly found in the United States which insures against financial loss from defects in title to real property and from the invalidity or unenforceability of mortgage liens. Title insurance is principally a product developed and sold in the...
by an independent title company, appraisal
Real estate appraisal
Real estate appraisal, property valuation or land valuation is the process of valuing real property. The value usually sought is the property's Market Value. Appraisals are needed because compared to, say, corporate stock, real estate transactions occur very infrequently...
and termite inspection of the property to ensure it has sufficient value, a land survey
Cadastre
A cadastre , using a cadastral survey or cadastral map, is a comprehensive register of the metes-and-bounds real property of a country...
to ensure there are no encroachments, and use of lawyers to ensure the closing
Closing
Closing may refer to:*The closing of a letter or e-mail: see Valediction or Complimentary close*The termination or closure of a business*Closing , the final step in executing a real estate transaction*Closing , making a sale...
is done correctly. These third party lender requirements add to closing costs which the lender requires the seller and/or buyer to pay. If the seller is also the lender, these costs are usually not required by the seller and may result in closing cost savings and fewer complications. It may also be the seller's position that if the buyer requires any of these services, he could pay for the costs and make arrangements himself. For properties where only relatively undeveloped land is involved and if the seller is willing to finance, the price of the empty land may be so low that the conventional closing costs are not worthwhile and can be an impediment to a quick, simple sale. Easy financing and a simple sale transaction may be a good selling point for a seller to offer a buyer.
The land contract may also allow the buyer to assign his equitable title/interest in the property to yet another buyer even before the loan is paid in full, subject to conditions in the land contract, effectively reselling his equity in the property to the new buyer.