Land Contract: What It Is & How It Works

Amy Fontinelle is a freelance writer, researcher and editor who brings a journalistic approach to personal finance content. Since 2004, she has worked with lenders, real estate agents, consultants, financial advisors, family offices, wealth managers.

Amy Fontinelle is a freelance writer, researcher and editor who brings a journalistic approach to personal finance content. Since 2004, she has worked with lenders, real estate agents, consultants, financial advisors, family offices, wealth managers.

Amy Fontinelle is a freelance writer, researcher and editor who brings a journalistic approach to personal finance content. Since 2004, she has worked with lenders, real estate agents, consultants, financial advisors, family offices, wealth managers.

Amy Fontinelle is a freelance writer, researcher and editor who brings a journalistic approach to personal finance content. Since 2004, she has worked with lenders, real estate agents, consultants, financial advisors, family offices, wealth managers.

Rachel Witkowski is an award-winning journalist whose 20-year career spans a wide range of topics in finance, government regulation and congressional reporting. Ms. Witkowski has spent the last decade in Washington, D.C., reporting for publications i.

Rachel Witkowski is an award-winning journalist whose 20-year career spans a wide range of topics in finance, government regulation and congressional reporting. Ms. Witkowski has spent the last decade in Washington, D.C., reporting for publications i.

Rachel Witkowski is an award-winning journalist whose 20-year career spans a wide range of topics in finance, government regulation and congressional reporting. Ms. Witkowski has spent the last decade in Washington, D.C., reporting for publications i.

Rachel Witkowski is an award-winning journalist whose 20-year career spans a wide range of topics in finance, government regulation and congressional reporting. Ms. Witkowski has spent the last decade in Washington, D.C., reporting for publications i.

Updated: Sep 27, 2021, 10:04am

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For the buyer, a land contract is an alternative to getting a mortgage or paying cash to buy a home. For the owner, it’s a way to sell property a bank may not want to finance. It can also be a way for a seller to expand the pool of potential buyers to include people who might not qualify for a traditional or government-backed home loan.

What Is a Land Contract?

A land contract is a legal agreement where the owner finances the buyer’s purchase of a piece of real estate. Despite its name, a land contract isn’t necessarily an agreement to purchase a vacant parcel (though it can be). It’s often a contract to buy a house plus the land under and around it.

Both parties make compromises under a land contract. The seller won’t get paid in full when the deal closes, like they would if the buyer got a mortgage or paid cash. Instead, they’ll get paid over time—if the buyer makes all the payments. The buyer often unknowingly sacrifices the legal protections they’d get with a rental agreement or mortgage finances.

Land contracts don’t have to be a bad deal for buyers. But they do have a decades-long history of being more advantageous for sellers than buyers and have been used for discriminatory practices. You should be keenly aware of this context if you’re thinking about entering into a land contract.

How Does a Land Contract Work?

The laws governing land contracts vary by state, but here’s how a land contract is generally supposed to work.

A buyer and seller draw up a contract that includes the following information:

• A legal description of the property
• Names and addresses of the buyer and seller
• Purchase price
• Down payment
• Interest rate
• Loan term
• Payment schedule (including an amortization schedule that shows how much of each payment goes to principal and how much goes to interest)
• Whether the property has any liens against it (for a mortgage or unpaid taxes)
• Whether the buyer must make a balloon payment (a lump sum to pay off the remaining principal at the end of the loan term)
• Whether the loan has a prepayment penalty (a fee for paying off the loan early)
• How the seller will penalize the buyer for late payments
• How much time the buyer has to catch up on a late payment
• Who is responsible for maintenance, repairs, taxes and insurance
• A requirement that the seller provide evidence of title
• A requirement that the seller legally record the agreement

After both parties sign the contract, the buyer gets an equitable title or a general warranty deed. These documents protect the buyer by allowing them to accumulate equity in the property and by preventing the seller from taking out new loans against the property or selling the property to anyone else. The buyer also gets the right to occupy and improve the property.

It’s important to note that the seller can also be called a vendor, and the buyer can be called the vendee.

The seller holds the legal title until the buyer pays off the property. This, combined with a contract (that may not spell out everything listed above), is why many buyers get fleeced in land contract deals. This is discussed further below. But first, it’s important to understand the types of land contracts.

Types of Contracts

A land contract may sound similar to a lease with an option to buy (purchase option) or rent-to-own agreement, but it’s not the same thing. A land contract is an agreement to purchase, whereas a lease or rent option is not.

Land contracts can go by many names:

• Land contract of sale
• Land sale contract
• Real estate sales contract
• Land installment contract
• Installment sales contract
• Agreement to convey
• Agreement for purchase and sale
• Contract for deed
• Articles of agreement for warranty deed
• Executory contract
• Contract for sale
• Poor man’s mortgage

Under a land contract, the buyer does become the owner once the land contract is signed. But the down payment under a land contract works like the nonrefundable option fee paid with a purchase option contract. Most importantly, in any of these arrangements, not having the cash or financing to complete the transaction at the end of the term means the buyer loses a lot of money and has to find another place to live.

Negotiation Process

Though state law may lay out certain requirements for land contracts, the terms are largely up to the buyer and seller. The buyer in a land contract might assume the seller has all the power, but that’s not true. They may have more money and more resources. But buyers can work toward leveling the playing field by knowing their rights and their options for protecting themselves.

Buyers should ask for certain protections and get them in writing in the contract. They should also seek the assistance of an attorney (preferably one who specializes in real estate) who does not represent the seller. A buyer considering seller financing may not have the money to hire an attorney, of course. Free assistance may be available from a local law clinic, legal aid society or nonprofit housing counseling agency. By not running the contract by a legal expert, you could stand to lose a great deal.

Check out the National Consumer Law Center’s key recommendations for how the Consumer Financial Protection Bureau regulates land contracts nationwide, though it is limited. These suggestions highlight the lack of federal (and often state) consumer protections for these deals. They also offer guidance on how you should seek to protect yourself as a buyer if you want to proceed with a home purchase using a land contract.

Land Contract Negotiations That Help Protect Buyers

If you are considering a land contract, there are a number of steps you can take to better protect yourself during the negotiations process.

• Monthly cost. When negotiating the monthly cost of a land contract, keep in mind that on top of principal and interest, you will be paying for taxes, insurance, maintenance and repairs. Ask yourself: Is the principal and interest reasonable and affordable after you add on these costs? Do you know how much they will be?
• Title search. It’s important to hire a reputable title company to do a title search and issue an owner’s title insurance policy before signing a land contract. Without these, you’re taking a major risk that someone other than the seller (whether the seller knows it or not) may have a claim to the property. That claim could threaten your ownership.
• Escrow service. Another smart way to protect yourself as the buyer in a land contract deal is to use an escrow service, attorney or financial institution as a neutral third party to hold the property’s deed during the payment period. By placing the deed in escrow, the seller shows good faith that they do intend to transfer the deed to the buyer once the buyer makes all the agreed-upon payments. At the same time, the escrow service protects the seller and will return the deed if the buyer does not pay as agreed.
• Appraisal. To make sure you’re paying a fair price for the home, order an independent, professional home appraisal. You’ll pay a few hundred dollars for the assurance that you’re not overpaying for the property. At a minimum, ask a local real estate agent if they’d be willing to give you their opinion on the home’s value.
• Home inspection. To make sure the home is in safe and sound condition, get a professional home inspection (another few hundred dollars). Land contract homes are sometimes in dreadful condition. You can also check with the local property tax assessor to see what the assessed value is for property tax purposes, and find out whether the property’s taxes are paid up. Assessed value is not the same as market value, however.
• Legal recording. The seller should file a short summary of the land contract, called a memorandum of land contract, with the city and county where the property lies. This document should include the buyer’s and seller’s names and a legal description of the property. It should be signed by both parties and witnessed by a notary. These steps formalize the agreement and make its existence a matter of public record to protect the buyer’s interest in the property. Your state may even require it.

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Buyer Beware

Sometimes the people or companies selling properties via land contract don’t have the buyer’s best interests in mind. Do an online search for “land contract” and the name of your state, and another search for “land contract” and the seller’s name, to look for red flags.

There are many land contract horror stories. To summarize them, the National Consumer Law Center says land contracts “allow investors to avoid responsibility for property upkeep while churning successive would-be homeowners through a property they could not legally rent.”

Land contracts are often marketed to people of color, immigrants and low-income individuals who can’t obtain traditional financing but can potentially set them up to lose money and their home.

How? Land contracts often make it all-too-easy for buyers to lose their money and equity they’ve put into the home. For instance, a land contract with a balloon payment (similar to a balloon mortgage) might be impossible for a buyer with low income to pay off or refinance when the time comes.

Along the way, the buyer could lose the home if they’re late on a single payment. Agreements often favor sellers and make it easy for them to evict or foreclose on buyers. In Ohio, the seller can bring court action against a delinquent buyer after just 40 days. For traditional banks and mortgages, it typically takes more than 90 days of delinquency.

Besides that, the seller might offer a land contract even if they don’t own the property free and clear and are still paying off a mortgage. Whie not illegal, one potential problem is that the lender can require the loan to be immediately paid off in full if the property’s owner changes hands. Another problem is that the seller could stop paying the mortgage while continuing to collect the buyer’s payments.

In Ohio, at least, the buyer is allowed to step in and make the seller’s mortgage payments if the seller stops paying. Those payments then count toward the buyer’s land contract installment payments. But this law assumes the buyer knows what’s going on.

Land Contract Alternatives

Rather than signing a land contract, a buyer who is short on cash and/or lacking good credit may be better off renting instead of buying, while saving up a down payment and improving their credit. Even without a down payment—or with a down payment as low as 3%—you can qualify for a low-down-payment conventional mortgage and possibly even get down payment assistance.

Another option is seeking a mortgage from a portfolio lender or credit union that offers more flexible underwriting standards. These lenders don’t have to follow the rules that Fannie Mae, Freddie Mac or the Federal Housing Association (FHA) lay out. They might have an option that would work for you and offer better terms and legal protections than a land contract.

Pros and Cons of Land Contracts

A land contract can mutually benefit the buyer and seller when both parties act in good faith and take the right steps to legally protect themselves. However, since it’s a less common way of selling property, land contracts come with fewer consumer legal protections than a traditional property sale. Whether you’re considering buying or selling a property with a land contract, it’s important to understand the pros and cons before deciding whether to proceed with a deal.

Pros

• Financing can be easier to obtain because the terms can be anything that works for the buyer and seller.
• It provides a way to buy a low-cost property when a small-dollar mortgage isn’t an option.
• The buyer won’t have to pay a mortgage origination fee, and other closing costs are optional (but recommended).
• It can potentially be refinanced with a traditional mortgage after the buyer improves their credit and saves up a down payment.
• It can be faster than buying a home with a mortgage.
• The seller may be able to earn a high rate of return.

Cons

• A buyer who can’t get traditional financing may not find a seller offering a land contract on favorable terms. Land contract interest rates may be much higher than conventional mortgage rates.
• The buyer could lose the home if the seller goes bankrupt, dies, is delinquent on taxes or stops paying the mortgage.
• State laws may not provide strong protections for the buyer in a land contract deal.
• For the seller, it can take a long time and/or considerable expense to foreclose on a non-paying buyer, depending on state law. While court action may be initiated within as few as 40 days, completing the trial could take a year or longer.
• Refinancing with a mortgage may not be possible for various reasons (property is in poor condition, buyer’s credit isn’t good enough, home value is too low, etc.).
• The buyer may not be able to use the land contract as collateral for another loan (like a home equity loan) and may not be able to assign or transfer their interest in the property until the contract is satisfied.

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