Many real estate investors look at land contracts and land trusts as the same thing, peas in a pod, never realizing that they are not the same at all.
A quick refresher. Land trusts are revocable living trusts providing the tandem of privacy and liability protection. A land contract is referred to as many things, a contract for deed, agreement for deed, a land installment contract, even an installment sales agreement, but never a land trust.
A land contract is a contract between a seller and buyer of real estate whereby the seller finances the buyer’s purchase from that seller for an agreed upon purchase price, the buyer agreeing to repay the loan in installments, typically paying a 2-3% down payment upfront of the negotiated purchase price. The seller retains legal title and the buyer takes possession following the closing. The purchase price is paid in periodic installments, often with a balloon payment affixed to the contract terms to minimize the breadth of payments over time. The seller conveys legal title to the buyer after all the payment terms are fulfilled. Not only does the legality of land contracts vary from state to state, as an investor there are Dodd-Frank and due on sale issues to contend with. Dodd-Frank has to do with the consumer protection afforded buyers with the payment terms and particularly the balloon attachment. It will not be addressed here. Not so with due on sale considerations if there is an existing lien on the subject real estate held by a third party lender at the time the parties enter into a land contract.
There are benefits to both parties with a land contract. Many buyers, with their circumstances and credit history, cannot obtain conventional financing. The buyer gets around this pitfall by dealing directly and only with the seller and the financing option offered. The buyer then makes monthly payments to the seller. For the buyer, there is no qualifying although the seller is sure to run the buyer’s credit, do a criminal records check, and most certainly negotiate as high a down payment as can be obtained. Down payment flexibility, contract terms, the interest rate and balloon, are all negotiable so they inure to the buyer’s benefit if the buyer wants and can afford the house, particularly with no conventional financing to fall back upon.
The seller gets to move his house at a price more to his or her liking and at a time it may not be otherwise moving. No appraisal, avoiding realtor fees, and minimizing holding costs are all benefits to appreciate. The seller may now be freed of his or her selling constraints causing the sale in the first place. The seller may now have a positive monthly cash flow and at a better rate of return from other investment choices.
There are risks to consider as well. The seller may have to evict the buyer if the monthly installments are not paid and there may be other and expensive legal costs if the buyer seeks enforcement of his or her equitable interest as a defense. The house may not be kept up as it should or may even be trashed before the buyer exits. The buyer may ask what can go wrong here? If the buyer misses payments, the ownership claim may be lost notwithstanding equitable rights that do vary from state to state. Both parties need to be clear on their rights, duties, and responsibilities under any executed land contract.
An even bigger concern, often undisclosed by the seller, is the status of an existing lien on the real estate. What happens if the buyer is making his or her monthly installment payments and the seller pockets that money, failing to pay the lender? What happens if the lender forecloses before title is transferred? What happens, as a condition precedent, if the seller fails to pay off the existing mortgage when the buyer has completed his or her contractural obligations? The transfer of a deed can become an issue. Due on sale, demand, and acceleration clauses may be in play at the time of any contractural transfer. The very act of a seller entering into a land contract with money due the lender, even if the seller is being honorable in each and every particular, may allow the lender to call the note due and require immediate and full payment. It is not uncommon for a lender to have an operative acceleration clause, a due on sale, or due on transfer clause to call the loan due that may be triggered with the execution of a land contract. The buyer will not be able to resolve that on the fly with conventional financing or going after the seller. The lender will have the deeper pockets, the buyer will not.
Another sobering caution for the buyer is the “as is” nature of land contracts. To get the seller’s blessing and financing, buyers are too often tasked with spending much of their disposable income on much needed repairs and renovations.
From an investor’s perspective, lease purchase options may be a better fit. Lease to own options and land contracts are different tools in the investor toolbox to transfer occupancy from someone who wants out to someone who wants in. It always boils down to knowing what you are doing and doing the right thing when you do. It is always smart to consider all available options before you act.