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Land contract: What is it and how does it work?
Land contracts offer a different way to finance a property purchase.
A land contract is an alternative option to purchasing a home with a traditional mortgage. Instead of making payments to a lender, the buyer makes payments directly to the seller. While this may be a good option for buyers who can’t qualify for a traditional mortgage, it does come with risk.
In the wide world of real estate, property can be purchased in many different ways. You can use a traditional real estate agency or brokerage. You could pursue a wholesale contract or work directly from buyer to seller. No matter which way you choose to find your property and coordinate the deal, you probably think a mortgage is involved. But a mortgage isn’t the only way to purchase property. With a land contract, you can purchase land, private housing, or commercial property without using a lender.
What is a land contract?
A land contract is structured similarly to a traditional mortgage, but instead of using a lender, the seller provides financing to the buyer. In a land contract, the buyer immediately begins managing the property. Over time, the buyer makes payments to the seller until the full purchase price is paid. The seller keeps the property title until that time, which means that even though the buyer may be managing the property, they don’t officially own it until they make the last payment on the contract.
A land contract may be an appealing option for a buyer who is unwilling or unable to get a mortgage because of poor credit, unreliable income sources, and a variety of other reasons that traditional lenders deem as a point of disqualification.
Land contracts have become more popular since the infamous mortgage crisis of the late aughts. Someone who has undergone a foreclosure, for instance, may be able to use a land contract to purchase a home they otherwise would not have been able to afford.
You can use a land contract for any type of real estate transaction, including vacant land, houses, apartments, condos, or commercial properties. If you’re considering making one, know how to write a contract properly to protect both the buyer and the seller.
Now that you can confidently answer what is a land contract, let’s answer the question: How does a land contract work?
How does a land contract work?
There are two main ways to structure a land contract:
- Traditional land contract. In this contract, the seller keeps the title to the property until the buyer fully pays off the debt. At the same time, the buyer receives an equitable title, which allows them to build equity in the property while they make payments. It also gives them the option to convert the land contract into a regular mortgage at a later time.
- Wrap-around land contract. In this contract, the seller continues to pay their existing mortgage. They pocket the difference between their monthly payment to the mortgage company and the monthly payments made to them by the buyer. The buyer gets the warranty deed to the property immediately after the land contract is signed, which means they own the property from the beginning. In addition to the buyer and seller, the seller’s current mortgage lender has to agree to this contract. The lender takes a junior lien position, which means that it can take control of the property if the seller stops making mortgage payments.
Once you decide which land contract structure you want to pursue, the land contract process will follow these general steps:
- Negotiate the terms. Together, the buyer and seller establish the terms of the land contract and draft the agreement. Terms include the purchase price, the down payment, the interest rate, and the payment schedule. Get a real estate lawyer’s input and review the drafted agreement.
- Conduct due diligence. Before signing the agreement, both parties should conduct thorough research on the property. Common steps in the due diligence process include arranging a property inspection, getting an appraisal, and completing a title search to confirm ownership and identify any existing claims or liens.
- Sign the contract. When both parties are satisfied with the terms and have conducted their due diligence, it’s time to sign the contract.
Land contracts are enforceable and binding documents. They require both parties’ signatures to be official. Using an e-signature platform like Adobe Acrobat for business can make the signature process simple and add another layer of validity and security to the contract. You can request signatures on PDFs, track the status of a contract sent for review and signing, and get real-time updates on important documents. You can also use generative AI to help you review and understand complex documents.
- Move in. The buyer moves into the property and begins to manage it.
- Make payments. The buyer makes payments according to the terms of the agreement. If the buyer fails to make payments or meet the terms of the contract, they forfeit their right to the property and lose any fees or payments already made.
- Transfer the title. Once the buyer makes the final payment, the deed is filed with the proper government agency, and the title is transferred. The buyer now officially owns the property.
What to include in a land contract.
While having a real estate law professional review any contract before signing is a good idea, you can write the first draft of the land contract yourself. You can also learn how to write a bill of sale for land or real estate or how to write a real estate purchase agreement to accompany your land contract.
A properly written land contract should include several components:
- Purchase price. Define how much the property will be sold for.
- Down payment. Define the amount due at closing, which may be a flat rate or a percentage of the purchase price.
- Interest rate. Define the amount of interest the buyer will pay and whether or not that rate can change over the course of the contract. If the interest rate can change, this section will also describe the timing and conditions for those changes.
- Payment schedule. Define how much each payment will be and how often payments will be made. This section may include information on late fees, whether a balloon payment is due at the end of the loan term, and any penalties for paying the loan off early.
- Responsibility of the parties. Clarify clauses that state the responsibilities that the buyer and the seller have to each other.
- Title settlement. Document when and how the title will be transferred during the agreement.
Pros and cons of a land contract.
While financing a property purchase with a land contract may be simpler than other alternatives, your interest rate is higher than using a traditional lender. Like any deal, land contracts offer benefits to both the buyer and the seller, but there are also disadvantages for both parties.
Pros
If you’re looking to get a foothold in the property ownership game or sell your own property, a land contract comes with several benefits:
- Simplifies financing. With lenders and mortgage brokers out of the picture, buyers can get financing even if they wouldn’t qualify for a traditional loan.
- Favors the seller. Sellers get a steady income stream for the course of the contract. If buyers don’t make payments, sellers can keep the property.
- Puts more in your price range. Because the parameters of a traditional loan don’t apply, buyers may be able to purchase a more expensive property.
Cons
While a land contract can make some aspects of purchasing and selling property simpler, it also comes with a unique set of challenges:
- Lacks contract standards. A land contract can include any terms that the parties agree to but can make unanticipated situations difficult to navigate.
- Uses higher interest rates. Sellers in a land contract take on most of the risk, so they may insist on a higher interest rate than a traditional mortgage would have.
- Confuses ownership. Though the buyer is managing the property, the seller keeps the title until the contract is paid in full, which can cause confusion.
- Increases buyers’ risk. If a buyer falls behind on payments, they may lose their investment. Sellers do not refund any money already paid toward the contract.
Land contract FAQs.
In a land contract, the seller maintains the title and official ownership of the land until the buyer makes their final payment. However, the buyer typically begins managing the property as soon as the contract is signed, which may lead to confusion and disputes about who is responsible for the land in a lawsuit or insurance claim situation like a natural disaster.
Both a land contract and an option contract involve a buyer and a seller, avoiding a third party like a lender. But what is an option contract in real estate? Unlike a land contract, an option contract doesn’t guarantee a purchase. An option contract is an agreement that puts a property on hold for a specific time frame at a set price and interest rate until a buyer decides whether or not they will go through with the purchase.
The terms land contract and contract for deed are interchangeable. Different regions use different real estate terms to describe the same types of deals. Depending on where you live, you may hear a land contract described as any one of the following:
- Contract for deed
- Installment land contract
- Land sale contract
- Memorandum of contract
- Real estate contract
- Bond for title
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Land contract: What is it and how does it work?
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Two people shake hands after creating a land contract for the buyer to finance a property purchase.
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