What is a land contract?
Land contracts are written agreements between a buyer and seller of real estate in which the seller provides financing to the buyer on agreed upon terms. The property under the contract can range anywhere from vacant land to an apartment building. Once the parties have executed their agreement and the buyer has made a down payment (if required) to the seller, the buyer can then obtain possession of the property immediately.
Why use a land contract?
For those experiencing trouble obtaining a traditional bank loan due to low credit or a recent bankruptcy filing, land contracts can provide a way for buyers to bypass the bank and instead work directly with the seller to finance the property. A Seller may also benefit from a land contract if the property being sold does not qualify for traditional lending. Land Contracts may also be an attractive option for selling between family members – particularly for adult children seeking to buy their parent’s home. Parties are often able to work out more favorable financing terms than what the bank can offer, making land contracts great options for first-time buyers in a less than favorable market.
How do land contracts work?
Like a mortgage, a buyer is still going to make a down payment on the property followed by installment payments, but these payments go directly into the seller’s pocket. The contract itself will work out payment frequency, but typically payments are made monthly with one final balloon payment at the end. The balloon payment is the balance of the loan owed to the Seller. The idea is that by the time the buyer reaches the final balloon payment and may need a loan to make that payment, enough time has passed to let the buyer’s credit heal thus allowing him or her to get a traditional bank loan. In some cases, the parties will agree to pay the total sum of the purchase price in monthly payments and no balloon payment will be required.
Land contracts are also sometimes referred to as “contracts for deed” because that is essentially the buyer’s goal – once all of the land contract’s terms are fulfilled, the seller will transfer ownership to the buyer via deed.
What happens if the buyer defaults on payments?
Because land contracts are legally binding contracts, a seller has a few options when a buyer fails to make timely payments:
- The seller could file suit for breach of contract seeking reimbursement through money judgement, garnishment, or other means,
- The seller could file suit seeking termination of the land contract (most appropriate when the buyer has simply disappeared), or
- The seller could seek foreclosure, giving the buyer a final opportunity to pay, and either having the property revert to the seller or have it sold if the buyer foregoes this final opportunity.
These options may vary depending on the land contract’s terms and the state where the property is located which is why a seller in a land contract should be vigilant in drafting the contract so as to include desired remedies in the event of a buyer’s default.
Is a lease-to-own agreement different than a land contract?
Lease-to-own agreements operate much differently than land contracts, as these agreements typically give a tenant the option to purchase the property at the end of the lease term for an agreed-upon price or agreed-upon future value. Whereas the payments made during a land contract are subtracted from principal and interest, payments that a tenant makes during a lease-to-own agreement may not necessarily count towards the price that the tenant ultimately pays to exercise their option to purchase, unless a rent premium provision is added. However, even with a rent premium provision, these agreements rarely allow the entire rent payment to be credited towards the purchase price.
Lease to own agreements often also charge tenants an option fee – this is an additional charge a tenant pays upfront to preserve their right to purchase at the end of the lease term. A tenant who ultimately decides not to exercise their option to purchase generally loses the additional rent premiums and option fee, as these are most often non-refundable.
There is a significant difference between title rights in land contracts and lease-to-own agreements. Buyers in land contracts hold equitable title to the property. This means that as long as the buyer is making the agreed-upon payments, the buyer has the absolute right to occupy the property and continue towards their right to purchase that property. While the seller in a land contract is still the holder of legal title, the seller cannot try to sell the property to anyone else.
A tenant in a lease-to-own agreement does not hold equitable title. The distinction between a buyer in a land contract with equitable title and a tenant in a lease-to-own agreement who holds no equitable title, is influential on which party pays taxes, insurance, and maintenance/repair fees. For example, it is standard for a buyer in a land contract to pay the real estate taxes and property insurance, whereas in a lease-to-own agreement, it is more typical of a landlord to pay those expenses.
The pros and cons of a land contract:
As a buyer in a land contract, the pros are obvious: the opportunity to obtain financing on property without a bank. However, sellers should be cautious of who they decide to contract with. Unlike banks, individual sellers do not have the luxury of obtaining comprehensive background information from a buyer and assessing whether this is a risk worth taking.
Parties seeking to enter into a land contract should seek the assistance of an attorney for drafting and explanation of its terms and conditions. Both parties will be better off if they fully understand their obligations and liabilities that can arise when contract terms and conditions are not followed.
Contact us today for a consultation at 262-725-0175 or our website’s contact page. Wynn at Law, LLC is based in Southern Wisconsin and has three office locations: Lake Geneva, Delavan, and Salem.
