Benefits and Risks of a Land Contract - Just Another Site

Benefits and Risks of a Land Contract

A land contract can be an appealing option for a potential homebuyer who might have difficulty qualifying for a mortgage loan. But there are potential risks to be wary of as well.

Land contracts were a popular way of buying a home back in the 1970s and 1980s, but fell out of favor in recent years as creative financing made it easy for almost anyone to qualify for a mortgage. However, they’ve been making something of a comeback lately as lenders have tightened credit requirements, sending some potential buyers in search of alternative financing.

A land contract is a fairly simple concept. Basically, the seller is financing the purchase instead of going through a mortgage lender. Instead of taking out a mortgage, the buyer agrees to make regular payments directly to the seller, who still retains title to the property. Once the debt is paid off, the seller transfers title to the buyer, who then owns the property free and clear.

Poor credit not an obstacle

The main advantage of a land contract is that it’s fairly easy to qualify for. As long as the seller is willing to go that route, there’s little need for extensive credit checks. If the buyer defaults, the seller simply retains the property without the need of going through foreclosure.

Also, because there’s no lender involved, the transaction is simply between the buyer and seller, without the involvement of a third party. This eliminates the need for appraisals or other hurdles a lender may insist on for a traditional mortgage.

A land contract is often viewed as a way to “pay down the purchase price” before obtaining a regular mortgage to buy the property outright. Often, the terms of the contract will call for 5-10 years of regular payments, concluding with a balloon payment for the balance of the mortgage. The buyers will typically plan on taking out a mortgage to make the balloon payment, since they will have had several years to improve their credit and earnings to qualify, and the loan needed for the balloon payment will be smaller than what would have been needed to buy the home up front.

Fewer protections for the buyer

On the downside, a land contract doesn’t have many of the protections that come with a mortgage. Because the seller retains the title until the land contract is fully paid off, the buyer could end up defaulting and forfeiting their interest to the property if they miss just one payment – in which case the buyer is entitled to keep the payments made to date as rent (Although buyers may be entitled to some of their money back in certain states – check local laws).

Going through a lender to obtain a regular mortgage can involve some hurdles, but it also provides some protections as well. Before granting a mortgage, a lender is going to insist on making sure that everything is in order legally – that the title is clear, there are no outstanding liens on the property, that it appraises for the purchase and that the deed is registered at the time of sale.

Also, when you buy a home using a regular mortgage, you own the property at that point and have certain rights as a result. And if you fall behind on your payments, you can’t be evicted from the property without the lender going through the entire foreclosure process.

When the seller still holds a mortgage

One of the biggest negatives that can occur with a land contract is when a buyer purchases a property on which the seller is still making mortgage payments. In some cases, the seller’s mortgage may specify that the lender can demand immediate payment in full if he or she no longer occupies the home – in which case the buyer could be compelled to come up with the full balance immediately if they wish to remain in the home.

Another possibility is that the seller might default on the mortgage and the lender forecloses – meaning the buyer loses the property unless he or she is able to work out an arrangement with the lender.

The laws on land contracts vary from state to state, so prospective buyers need to investigate whatever rules apply in their area. As with any major financial transaction, it’s a good idea to get professional assistance before engaging in a land contract, preferably a real estate attorney who can review agreements beforehand and alert you to potential pitfalls to avoid and steps you should take.

Now that you are aware of all the benefits and risks of a land contract, you’ll be more confident in making smarter, financial decisions. Never rush into a land contract and it’s pertinent to evaluate all your options before committing yourself into a serious contract.