Land Contract Terms
A land contract is a written agreement between a person who has sold property ("the Seller or Vendor") and the person who bought that property ("the Purchaser or Vendee").
At the time a Seller finds a Purchaser for their property, they will probably prefer a cash sale. However, selling the property on a Land Contract provides a quick and inexpensive way to sell the property without the rigid guidelines, hassles and delays of bank financing. The contract also provides the Seller with monthly income and a good rate of interest, while using the property as collateral.
Land contracts are a sensible way to sell property and are extremely common all over the United States. In some states, they are called Trust Deeds, Contract for Deed, Deeds of Trust, Notes, or (privately held) Mortgages, but they all represent the same thing: a way of selling property where the Purchaser borrows from the Seller rather than paying cash up front or borrowing from a bank.
Although land contracts are relatively simple documents, we suggest that you have a legal professional or Title Company prepare them for you. Each state has its own laws and intricacies that need to be included in your contract.
Main Parts of A Land Contract
Not all contracts will follow the exact same order, but we have attempted to cover the key topics below;
Parties to the Contract, Legal Description, Price and Terms of Payment, Purchaser's Duties, Taxes and Insurance, Seller's Right to Mortgage, Seller's Duty, Default, Assignment of the Contract, Miscellaneous Provisions, and last, Signatures and Notary.
The contract begins with the "parties"-the people (and their addresses) who are entering into the contract. The "Seller" (Vendor) is the person who sold the property and is usually listed first. The "Purchaser" (Vendee) is the one purchasing the property and is usually listed after the Seller.
The Seller agrees to convey (sell) to the Purchaser only, a carefully described parcel of land. This description must be exact. When the purchase is completed and paid off, this should match the description on the deed. The city, village, or township of the property is noted, together with the county and state.
Along with the actual "earth" sold, the Seller also conveys such things as any buildings, easements, tenements, hereditaments, improvements and appurtenances. In short, the Seller conveys everything that is permanently affixed to the property.
This area should contain all the figures and dates:
The date of the Contract is here at the beginning as well. Interest starts to "accrue" (begins being owed to the Seller) starting from the date typed in, at the top of the contract. Consequently, when the first payment is due, one month's interest is usually already owed, since it is paid in arrears.
Total purchase price, down payment, beginning balance remaining (the purchase price minus the down payment), monthly payment (or annual or semi-annual payment), an interest rate (usually stated in terms of an annual rate), the date of the "balloon" payment (if any), and date that the first payment is due.
Purchase Price - The Purchase price (sometimes referred to as "consideration") is negotiated between the Seller and the Purchaser. Properties sold on a land contract often sell for more than properties that are sold for cash because the Seller provides the all-important financing.
Down Payment - The down payment is usually 10% to 20% of the purchase price. From the standpoint as the Seller, the bigger the down payment the better. It represents money that does not have to be collected in the uncertain future and it also represents the Purchaser's commitment to the property. Sometimes, non-cash down payments (barter items such as used cars, snowmobiles, applied rent, etc.) are used as a down payment. This can be a very creative way to structure a sale!
Balance Remaining - Initially, this amount is the purchase price minus the down payment. The balance remaining will go down each month with the payments made by the Purchaser. An amortization schedule shows how the balance will be reduced if monthly payments are made on time.
Monthly Payment - The monthly payment is usually about 1% of the beginning balance. If after the down payment the Seller is owed $20,000 by the Purchaser, the monthly payment will probably be in the neighborhood of $220. The smaller the monthly payment, the longer it will take to pay off the land contract and the larger the monthly payment the faster the contract can be paid off.
Payment Due Date - This is the date when the first payment is due and usually the day of the month each consecutive payment is due.
Grace Period - A grace period in some contracts permits the Purchaser a few days each month during which he or she may fail to make payments and not be considered in default. Some contracts provide for a late fee if the payment is not received on time or within the grace period. Grace periods and/or late fee clauses are usually typed in as miscellaneous provisions at the end of the land contract. Many people mistake the last day of the grace period as the payment due date. Remember that even though a late fee you is not charged, the payment is still late.
Balloon Payment - If a contract contains a clause that reads something like, "the entire purchase price and interest shall be fully paid within 5 years from the date hereof, anything herein to the contrary notwithstanding," then there is what is known as a "balloon" in the contract (a five year balloon, in this example). A balloon payment is the term used for a lump sum, final payment on the contract. Balloon clauses usually call for the final payment to be made on a specified date. If the Purchaser fails to make a balloon payment when required, this will constitute a default on the contract.
Interest Rate - The interest rate is usually stated in annual terms, (e.g., 11%). When recording each payment made, interest is calculated for the payment period (usually monthly) by multiplying the interest rate by the balance due and then dividing this annual interest amount by the number of payments to be made each year. This number (total interest for the period) is then deducted from the payment. The rest of the payment is known as the principal portion of the payment and is deducted from the remaining principal balance on the contract.
The person responsible for making tax and insurance payments can vary depending on the terms of the land contract. The three most common ways to handle the payments of taxes and insurance on the property are as follows:
1. The Purchaser pays taxes and insurance.
2. The Seller pays taxes and insurance but then adds the amounts paid back to the balance on the contract.
3. The Purchaser makes monthly contributions to an escrow account held by the Seller and the Seller pays taxes and insurance out of this account.
Method 1: Purchaser pays the Taxes and Insurance
Most often the Purchaser is responsible for paying the taxes and insurance on the property. A typical clause in a land contract where the Purchaser pays the taxes and insurance reads something like this:
"The Purchaser agrees to pay all taxes and assessments hereafter levied on said premises before any penalty for non-payment attaches thereto and submit receipts to Seller upon request as evidence of payment thereof; also at all times to keep the buildings now or hereafter on the premises insured against loss and damage in a manner to an amount approved by the Seller and to deliver the policies as issued by the Seller and to deliver the policies as issued to the Seller with the premiums fully paid."
Method 2: Seller Pays and Adds Amounts Spent Back to Contract Balance
Since failure to pay either the tax or the insurance bills can seriously jeopardize the value of the property securing the land contract (imagine trying to collect payments on an uninsured home that just burned down!), some Sellers insist on paying the tax and insurance bills themselves. After paying the bills, the Sellers just add the costs of insurance and taxes back onto the balance of the land contract at the time that the bills are paid. Contracts of this type are sometimes referred to as "Add Backs".
Under this option, the monthly payment will be supplemented with an amount to cover approximately one-twelfth of the estimated taxes and insurance. These larger payments (larger, that is, than they would be if they covered principal and interest amounts only) are treated just as if the entire amount of each payment was for principal and interest
This makes the balance on the contract drop more quickly than it normally would. However, when the tax and insurance bills come to the Seller, the Seller pays them and adds the amounts spent to the balance due on the land contract. Thus, the balance on the land contract, after having been reduced each month more than it normally would be because of the larger payments, is re-adjusted upward when the amounts for taxes and insurance are added back to the contract balance.
A typical clause in a contract where the Seller pays the taxes and insurance and adds them back to the contract reads something like this:
"The Purchaser is to pay monthly, in addition to the monthly payment hereinbefore stipulated, the sum of $__________, which is an estimate of the monthly cost of taxes, special assessments, and insurance premiums for the land, which shall be credited by the Seller on the unpaid principal balance owed on the contract. If Purchaser is not in default under the terms of the contract, Seller shall pay for Purchaser's account the taxes, special assessments and insurance premiums mentioned above when due and before any penalty attaches, and submit receipts therefore to Purchaser upon demand. The amounts so paid shall be added to the principal balance of this contract."
Method 3: Seller Pays Taxes and Insurance out of Amounts Put in Escrow
A third way to have taxes and insurance handled, similar to Method 2, is for the Purchaser to pay approximately one-twelfth of the estimated taxes and insurance along with each monthly payment. The Seller then sets this extra part of the payment aside each month into what is called an "escrow account" to pay the tax and insurance bills as they arise.
If the escrow account is ever too low to pay the bills, the Seller notifies the Purchaser and a new, larger escrow payment is included along with the next monthly payment.
A typical clause in a contract where the Seller collects an additional sum of money and deposits it into a separate account (called an escrow account) reads something like this:
"The Purchaser is to pay monthly, in addition to the monthly payment herein before stipulated, the sum of $__________, which is an estimate of the monthly cost of the taxes, special assessments, and insurance premiums for the land, which shall be deposited in a non-interest-bearing account."
It is the Purchaser's duty to protect the value of the property he or she is buying until it is paid in full. This clause is important because the value of the property is what keeps the Purchaser making payments. If the Purchaser ever defaults and suffers foreclosure, it is the value of the property that should enable Seller to re-sell without a loss.
Most contracts require the Purchaser to notify the Seller in writing before the Purchaser or any third party commits waste (neglects the property or allows it to be used in a way that lessens its value) or removes, changes or demolishes any buildings or improvements on the premises in a way which may diminish the property's value.
After the Purchaser makes the final payment on the contract without default, the Seller must convey the property by signing a Deed to the property.
At the time of delivery of the Deed, the Seller often also delivers an abstract of title or a policy of title insurance showing that the property is free and clear from any lien that the Seller may have remaining on the property. Which person that will pay for the cost of the insurance should be agreed upon when the terms of the purchase are made.
It is the Purchaser's responsibility to record the Deed. The fee is nominal and recording the Deed will show as a matter of public record that the Purchaser is the new owner of the property.
The Seller has the right to borrow against his or her remaining equity in the property sold. In other words, if the Seller owned a $50,000 property free and clear and then sold it to the Purchaser who made a $10,000 down payment, the Seller initially has the right to collect $40,000 (his or her remaining equity in the property) and he or she may borrow money by allowing a lender to put a senior lien on the property (ahead of the Purchaser's interest in the property) for up to $40,000. However, since the Seller must be in a position at all times to convey the Deed to the property when the Purchaser makes the final payment on the contract, the Seller can never owe someone else more than he or she is owed by the Purchaser.
To protect the Purchaser from any debts that the Seller may have against the property, the Seller must provide notice of any such mortgage and its terms in a certified letter to the Purchaser. The Purchaser also has the right to make the payments for the Seller on any debt for which the Seller is in default. Any such payment made by the Purchaser, of course, will be deducted from the monthly payment owed by the Purchaser to the Seller.
In short, the Seller must never owe on the property more than he or she is owed.
A Seller almost always has the right to freely assign his or her interest in the land contract. (An exception might be if the Seller is still making payments on the property himself or herself and the contract governing that purchase restricts the Seller's ability to assign.)
The Purchaser, however, often has the right to assign his or her interest in the contract only after obtaining written permission from the Seller. This protection for the Seller exists because the Seller may have sold the property to the Purchaser on the strength of the Purchaser's character, time on the job, or credit rating, among other things. When this Purchaser then proposes that a new person begin to be primarily responsible for making payments to the Seller, the Seller has the right to know and approve this in writing.
Such an assignment by the Purchaser to a new purchaser usually does not release the original Purchaser from obligations to perform under the contract if the new purchaser fails to live up to the terms of the original land contract.
If the Purchaser fails to perform any significant part of the contract, the Seller may have the right, after notifying the Purchaser in writing of the exact nature of the default, to treat all payments already made on the contract as mere rental payments made by the Purchaser. Some states have very specific guidelines regarding default, so be sure to check with your legal professional. If the default continues, the Seller has the right to declare the remaining balance due and payable, and if the default is not then cleared up or the contract is not paid in full, the Seller can begin steps to regain possession of the property. Improvements made to the property by the Purchaser then become the Seller's property.
Defaults by the Purchaser may include failure to make timely payments, failure to properly maintain the property, failure to adequately insure the property, or failure to pay taxes on the property as they become due.
All contracts end with a series of miscellaneous provisions regarding where payments and notices should be mailed, which state laws govern the contract, and so forth. The provisions in a standard pre-printed land contract are not nearly as important as any typed provisions at the end of the contract. Read and enforce these typed provisions carefully.
To have a contract that can be recorded in the county records where the property is located, be sure to have the contract notarized by a licensed notary. The fee, if any, is usually nominal.
Also, have two witnesses available to observe the signing of the contract.
A land contract signed without witnesses or a notary should be fixed with the help of a local attorney or title company. This will enable the contract to be recorded for the safety and benefit of all parties.
Selling on a land contract can be an excellent way to sell a property quickly and at a good price. As conventional financing becomes even more costly, more difficult to obtain and more time consuming, Seller financing will become even more popular. (We estimate that approximately 25% of property sold is now sold with Seller financing.)
When thinking about selling a property on land contract, here are some things that should be known. The way a contract is planned and written can have a lot to do with its sales value in the future.
The purchase price is negotiated between Seller and the Purchaser, but there are some objective standards that can be used as the basis for negotiation.
One method is to have three different real estate agents do a market analysis on the property, complete with two or three "comparables" each. (Comparables are properties that are comparable to the subject property and can be used to determine its market value.) An average of these three analyses will usually give the Seller a good idea of what the property should sell for. This service is often free since the real estate agents will be competing for the right to list the property. The agent you feel most comfortable with is the one should list your property with. Attempt to find the three agents that represent most of the listings in the area your property is located.
A second method is to hire an independent appraiser to do a complete appraisal of the property, which would include (as above) at least three comparables. This method is more expensive (from $150 to $300) but is also more authoritative and is usually a much better gauge of the true market value.
The down payment is usually at least 10% of the selling price. However, a larger down payment means the Purchaser has more equity and owes less, both of which make the contract more secure and thus more salable. A good thing to remember is that the larger down payment, the more a land contract is worth. The length of time the contract has been in existence also will affect the salable value of that contract. Most companies that purchase land contracts prefer older (seasoned) contracts. They show that the Purchaser is a safe risk.
The Interest Rate
The interest rate on a land contract should be at least equivalent to interest rates currently charged on mortgages by banks and savings and loan associations; preferably 1% higher. There are legal maximums in most states on land contracts between individuals. See your legal professional for details.
The Monthly Payment
A formula of 1% per month on the unpaid balance at the time of sale is a good general rule. Here's an example:
$25,000 selling price of property
-$5,000 20% down payment
$20,000 balance due
$200 monthly payment (1% of balance due); add to this one-twelfth of the estimated taxes and insurance.
On smaller land contracts (under $15,000), a monthly payment greater than 1% of the balance due is generally required.
To determine how long a contract will run given a certain interest rate and payment amount, just call a title company and they can look it up for you. There are also many good sites on the Internet that will run an amortization. This service is usually free. Assuming an interest rate of 9% in the above example, the land contract would run for 186 months (15.5 years).
Lending institutions generally require the buyer to pay one-twelfth of the estimated yearly real estate taxes per month and one-twelfth of the estimated insurance costs in addition to the monthly payment. At the end of the year, they have the money on hand to pay the taxes and insurance. This is also the wisest thing to do when selling on a land contract. Since the land contract will run over a period of time, there is always the chance that property taxes will be raised, so be sure to include a clause in the land contract that provides for increasing the payment when this happens.
If a Seller currently owe on a piece of property, they do not necessarily have to pay off the present land contract or mortgage. Instead, they can usually continue to make monthly payments in the required amount just as before the new land contract sale. (The original obligation is often referred to as "underlying debt" since it "underlies"- is superior to and existed before- the debt owed on the more recent sale of the same property.) Sellers should check the land contract or mortgage they are making payments on, however, to see if there is a so-called "Due on Sale" clause requiring them to pay off the debt if they resell the property. Finally, a Seller should require the land contract payment being received to be at least 25% greater than the payment they will continue to make to the original Seller.
How long a land contract is scheduled to run is referred to as the contract's amortization. A contract's amortization depends on the size of the contract, the size of the monthly payment, and the interest rate being charged. (The higher the interest rate and/or the smaller the monthly payment, the longer the straight amortization will be. This is why a balloon payment is sometimes considered. Contracts with a 10- to 20-year amortization are common and are preferred to contracts with a 30-year amortization. Balloons usually are set for 5 or 10 years from the date the contract begins.
The Purchaser's Credit-worthiness
Just like any lender, the Seller has every right to information that shows the Purchaser has an adequate source of income to pay the land contract obligation. They can request references, find out where the Purchaser works and his or her annual income, and obtain a credit report showing how promptly he or she is paying current debts. If selling to a person with less than a commendable credit record, many Sellers increase the down payment and periodic payment requirements.
Memorandum of Land Contract
Many times the Purchaser or Seller does not want to put on public record all of the details of the financial transaction. In these cases a Memorandum of Land Contract can be drafted, signed by all parties, witnessed and notarized.
By recording this Memorandum both parties have put the public on notice that some agreement does exist regarding the sale of a particular property. This Memorandum filing is also cheaper than recording a land contract since Memorandums are typically only one page.
There are many ways of getting cash from a land contract. A Seller can sell the whole contract now or, if they just need $2,000 to $5,000 for some short term goal, they can sell just a few payments now and collect monthly payments again in the future. Many of these plans can even give up to 95% or even 100% of what is due on the contract.
Why Would I Want to Sell My Land Contract?
When you convert part or your entire land contract into cash, you gain several advantages in addition to immediate cash:
1. You receive a substantial sum of cash right now-enough to accomplish some major goals
2. You don't have to worry about collecting monthly payments or servicing you contract.
3. You don't have to worry about whether the taxes and insurance premiums are being paid each year to protect your investment.
4. You don't have to worry about whether your Purchaser will continue to make his or her payments
(1) Joint Tenancy: property owned by two or more people at the same time in equal shares; typically referred to as the four unities (unity of time, title, interest and possession vesting in each joint tenant). Each joint tenant has an undivided right to possess the whole property and a proportionate right of equal ownership interest. When one joint tenant dies, his/her interest automatically vests in the surviving joint tenant(s) by operation of law. Words in the deed such as "John and Mary, as joint tenants with right of survivorship and not as tenants in common" establishes title in joint tenancy. Not all the states allow this form of property ownership.
(2) Tenancy in the Entirety: some states have a special form of joint tenancy when the joint tenants are husband and wife -- with each owning one-half. Neither spouse can sell the property without the consent of the other. Words in the deed such as "John and Mary, husband and wife as tenancy in the entirety" establishes title in tenancy by the entireties.
(3) Sole Ownership: owned entirely by one person. Words in the deed such as "John, a single man" establishes title as sole ownership.
(4) Tenants in Common: property owned by two or more persons at the same time. The proportionate interests and right to possess and enjoy the property between the tenants in common do not have to be equal. Upon death, the decedent' s interest passes to his/her heirs named in the will who then become new tenants in common with the surviving tenants in common. Words in the deed such as "Peter, Paul, John and Mary as tenants in common" establishes tenancy in common.
(5) Community Property: only in states that recognize community property, a special form of joint tenancy between husband and wife, each owning one-half. Upon death, the decedent's interest passes in a manner similar to tenants in common. Words in the deed such as "John and Mary, husband and wife as community property" establishes community property ownership.
The vast majority of real estate transactions use four major types of deeds to convey title. The difference in the types of deeds is primarily the covenants and warranties conveyed by the grantor to the grantee. They vary from few-to-none to significant warranties conveyed in a general warranty deed.
1. The General Warranty or Warranty Deed
The General Warranty Deed provides the highest level of protection for the buyer. There are significant covenants or warranties conveyed by the grantor to the buyer/grantee.
A real estate buyer is best protected by a Warranty Deed. The seller or grantor conveys the property with certain covenants or warranties. The grantor is legally bound by these warranties. Whether expressly written into the deed, or implied by certain statutory words.
2. The Special Warranty Deed
The Special Warranty Deed doesn't provide as much protection for the buyer as does the general warranty deed. The grantor provides fewer warranties.
The special warranty deed is not nearly as protective of the buyer as is the general warranty deed. The grantor of a special warranty deed conveys the property with two warranties:
•The grantor warrants that they have received title.
•The grantor warrants, unless noted specifically in the deed, that the property was not encumbered during their period of ownership.
The grantor of the special warranty deed, in effect, only warrants the title against their own actions or omissions. They warrant nothing prior to their taking title. If specifically stated in the deed, other warranties can be conveyed. Special warranty deeds are frequently used by executors and trustees.
3. The Bargain and Sale Deed
With the Bargain and Sale deed, the buyer gets no protection from encumbrances. This deed type has very specialized uses.
A bargain and sale deed does not warrant against any encumbrances. It does imply that the grantor holds title to the property. Since it does not warrant good title from the grantor, the grantee could be in trouble if title defects appear at a later date. This type of deed is used frequently in tax sales and for foreclosure actions. As with the special warranty deed, other warranties can be conveyed in a bargain and sale deed if they are specifically stated.
4. The Quitclaim Deed
The Quitclaim Deed provides the least protection for the buyer of the four main types. Its uses are very limited.
The quitclaim deed is the least protective deed for the buyer. Basically, it only conveys what ever writes our interests the grantor has in the property. It provides no warranties or covenants to the buyer. If the grantor has good title, the quitclaim deed is as effective as a general warranty deed, but with none of the guarantees. Quitclaim deeds are frequently used to cure defects in the title. Quitclaim deeds are frequently used to transfer property between family members also.
A Deed in lieu of foreclosure or forfeiture:
A Deed in lieu of foreclosure or forfeiture is a deed instrument in which a borrower conveys all interest in a real property to the the lender to satisfy a loan that is in default and avoid foreclosure proceedings.
It offers several advantages to both the borrower and the lender. The principal advantage to the borrower is that it immediately releases him/her from most or all of the personal indebtedness associated with the defaulted loan. The borrower also avoids the public notoriety of a foreclosure proceeding and may receive more generous terms than he/she would in a formal foreclosure. Another benefit to the borrower is that it hurts their credit less than a foreclosure does. Advantages to a lender include a reduction in the time and cost of a repossession, lower risk of borrower revenge (metal theft and vandalism of the property before sheriff eviction, and additional advantages if the borrower subsequently files for bankruptcy.
In order to be considered a deed in lieu, the indebtedness must be secured by the real estate being transferred. Both sides must enter into the transaction voluntarily and in good faith. The settlement agreement must have total consideration that is at least equal to the fair market value of the property being conveyed. Sometimes, the lender will not proceed with a deed in lieu of foreclosure if the outstanding indebtedness of the borrower exceeds the current fair value of the property. Other times, lenders will agree since they will end up with the property anyway and the foreclosure process is costly to the lender.
Because of the requirement that the instrument be voluntary, lenders will often not act upon a deed in lieu of foreclosure unless they receive a written offer of such a conveyance from the borrower that specifically states that the offer to enter into negotiations is being made voluntarily. This will enact the parol evidence rule and protect the lender from a possible subsequent claim that the lender acted in bad faith or pressured the borrower into the settlement. Both sides may then proceed with settlement negotiations.
Neither the borrower nor the lender is obliged to proceed with the deed in lieu of foreclosure until a final agreement is reached.