What is a land contract?
A land contract is a contractual agreement between a buyer and a seller of real estate—usually residential real estate. This type of real estate purchase contract is a very popular form of “seller financing”, in the form of an installment sale. The contract spells out the price and other terms of the agreement, such as how taxes, insurance, utilities, and non-payment will be handled. As part of the contract, the seller agrees to provide a deed (usually a warranty deed) to the buyer after all of the terms of the contract have been met. For this reason, land contracts are often called a “contract for deed” because the deed does not pass to the buyer until the final payment has been made.
Why would an investor utilize a land contract?
There are several reasons someone may choose to sell or buy real estate utilizing a land contract. Here are just a few of the most popular:
• A land contract may make the property easier to sell. Since the seller is the qualifying agent and controls the stipulations of the contract, the seller may set their own requirements for the credit worthiness of the buyer, the amount of the down payment or any other item that might typically be dictated by a bank or some other 3rd party. And, because the seller is setting the terms and conditions, they can establish payments that fit within the buyers budget and utilize the option of accelerating the loan through a balloon payment at some future date.
• There are tax advantages using the installment sale method, as well. Taxes from the sale of a property are usually computed on an income-minus-basis method. With an installment sale, the taxable income can be spread out over a number of years instead of taken in the year of the sale. In other words, you can avoid paying all the capital gains tax at once.
• The seller on a land contract can enjoy a regular cash flow without the headaches of managing rental property.
• The seller may be able to realize a greater overall profit from the sale by earning interest. The seller may charge interest up to 11%. (And, in some cases an even higher rate of interest.)
• As a buyer real estate investor, you may utilize a contract as a way of getting control of a property with very little or no cash and then sell the property for a higher price or utilize it as a rental property.
• Land contracts can also be used as part of a transaction to provide the balancing security (paper) in the sale or exchange of property, for example: “I’ll give you my single family home and a land contract, for your four-family rental property.” The land contract is used to balance the equity.
• And, in case of non-payment on the contract, the forfeiture period is only 90 days from the date of filing, and the paper work is very similar to that of tenant evictions.
What are the disadvantages of a land contract?
There are a few down sides to selling or buying on a land contract. Here are some examples:
• Title does not pass to the buyer; therefore, a government based property maintenance inspection department could interpret that the ownership of the property—and therefore the maintenance of the property—is also the responsibility of the seller.
• Land contract terms typically state that the seller can only mortgage up to the contract balance, and, if seller defaults, the buyer can step in and make the mortgage payments. A problem usual occurs because the buyer doesn't learn of the default until there has been acceleration and foreclosure. Even then, buyer having an interest in the property would have redemption rights against the mortgage holder.
• In a case of forfeiture, the seller must have a complaint for forfeiture of land contract served on the buyer/defendant utilizing personal service. This requires the seller to know where the buyer is—physically.
• The buyer can redeem the property on the 89th day of the forfeiture process by paying the amount listed on the original complaint. This means land contract payments could be in arrears an additional three months when the buyer redeems the property.
• Finally, a Michigan Supreme Court has ruled that in a forfeiture action the seller may not sue for any additional damages beyond recovery of the property. This means that you cannot get additional money for physical or other damages if you recover the property.
How is a land contract different from a mortgage?
Mortgages exist after the deed has passed to the new owner. The buyer or new owner receives a warranty deed from the seller. He then uses his new property to secure a loan from a lender. This security is given to the lender in the form of a note and a mortgage. The note creates the debt and the terms and condition of repayment. The mortgage secures the note. Land contracts describe the terms and conditions of ownership and how title will pass upon fulfillment of the contract.
18th of October, 2010