What is a land contract in real estate?
If you’re considering buying a property, you’re probably wondering what your financing options are.
You’re likely already familiar with the basic ins and outs of personal loans and mortgages.
Land contracts are another way to pay for a property and an option that might be attractive if a conventional mortgage or a personal loan is out of the question due to issues such as poor credit.
What is a land contract?
A land contract is a legal contract or agreement that you can use to buy property, including land, a house, or a commercial building.
It’s a way to finance buying property, not dissimilar to traditional mortgage financing, often with a monthly payment plan.
A key difference is that instead of borrowing money from a bank or lender, you make regular payments in the form of installments to the owner of the property you’re purchasing until you pay off the price of the property.
Land contracts are also referred to as contracts for deeds and land sale contracts, among many other alternatives.
How does a land contract work?
A land contract is a contract negotiated between the buyer (vendee) and the seller (vendor) of a parcel of land or property.
The seller agrees to take incremental payments toward the full purchase price and to essentially sell it gradually over time.
The buyer, meanwhile, must abide by the legal terms within the land contract, including — crucially — keeping up those payments.
The two main types of land contracts are known as traditional and wrap-around land contracts:
- A traditional land contract means the seller keeps the legal title of the property until the land contract has been paid off — I.e., until the buyer has covered the full purchase price.
- In a wrap-around land contract, the buyer gets the warranty deed to the property immediately, meaning they own the home from the beginning of the contract. The seller, meanwhile, must keep paying off any existing mortgage but can keep the difference between their mortgage payment and what they’re paid each month by the buyer. These agreements must also, understandably, be agreed to by the seller’s mortgage lender.
In general, both types of land contracts usually have installment payments, and at the end of the contract term, the buyer may have to make a lump sum balloon payment to pay off the loan.
What are the disadvantages of a land contract?
One drawback as a buyer is that you’re reliant on the seller to keep up with the mortgage payments in the case of wrap-around land contracts.
You could end up losing the house you’re investing in if the seller stops making payments.
Land contracts can also be a little unclear in terms of their conditions, so you’ll want a specialized attorney to review your contract and make sure it’s foolproof.
You may also run the risk of being charged higher interest rates in price negotiations by the seller because they’re taking on a bigger risk than going through a traditional mortgage route.
Finally, while you’re entitled to an equitable title in a simple land contract (you gain equity as your payments are made), the seller holds the legal title until you’ve fully paid for the property.
If any legal disputes or insurance claims arise during this period while you’re still paying for the property, it can be a legal gray area about who’s held responsible.
This is another thing you should clarify in your contract.
How to write a land contract
The first step is to negotiate the basic terms of your contract, such as the total purchase price, down payment, interest rate (if applicable), any penalties for delayed payment, any rules for default, and the length of time you have to complete the payment.
The next step is to outline the parties and the purpose of the contract.
The contract can be entitled “Land Contract.” Clearly, state which party is the buyer and which is the seller.
Then, identify the property with its legal description (from the title deed).
Next, insert the down payment amount, if applicable.
Then list the purchase price, interest rate, and total purchase price (i.e., purchase price plus total interest). Stipulate whether the buyer can avoid interest by paying installments early.
Outline when each installment is due, as well as the cost of each installment.
You should then create a section that stipulates any late payment penalties and the conditions for default.
In many states, if the buyer defaults at any point, the seller can seize the property, and the buyer may receive no refund for the amounts already paid.
Include a statement stipulating that the seller must transfer the title to the buyer once the total purchase price is paid.
Finally, insert a signature line that mentions the parties by name. To make life easier you could customize one of PandaDoc’s many real estate templates to suit your needs.
We offer real estate agency agreement templates, lease agreement templates, and more, too.
What happens if a buyer defaults on a land contract?
If a buyer defaults on a land contract, the seller can put the property into forfeiture.
If the buyer has the ability to pay everything owed (including interest and penalties), the contract continues to be in effect, and the buyer’s investment is protected.
If the seller opts for foreclosure, the entire amount owed is payable instantly.
If the buyer can’t pay the seller in full, the buyer will be evicted. The property will be sold to pay the balance due. In some states, the seller may choose to repurchase the property at the foreclosure auction.
Manage your land sale contracts effectively with PandaDoc
Land contracts can be confusing and difficult to navigate, so they require clear terms and conditions to protect homeowners and homebuyers during the sales process.
Real estate contract management software features like those offered by PandaDoc can help you protect your interests so forfeiting never comes into the picture.