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Written by
Michele Petry
Edited by
Troy Segal
Troy Segal is a senior editor for Bankrate. She edits stories about mortgages and home equity, along with the finer financial points of owning and maintaining a home.
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Those who want to buy a home but can’t qualify for a mortgage — or perhaps don’t want one — can sometimes find a path to homeownership via a land contract. Land contracts offer a streamlined and often less expensive way to buy or sell a home or land. However, there are enough risks involved that it’s a smart move to explore all of your mortgage options before committing to one.
A land contract goes by a variety of names. You may also hear it called a contract for deed, bond for title or installment land contract. In essence, it’s a legal agreement for a seller-financed purchase that doesn’t involve a bank or other mortgage lender. Instead, the buyer makes monthly or periodic payments directly to the property owner until the sale price is paid in full.
Those whose credit has been damaged by a short sale or foreclosure may be able to use a land contract to buy another home. It might also be an option for buyers who don’t have enough money saved for a down payment and closing costs, or for forward-thinking sellers seeking to spread out the gains from the sale for tax purposes.
Generally, the use of land contracts tends to increase when credit is tight. They are more common in low-income neighborhoods, where public agencies and nonprofit housing groups use them to help families attain homeownership and to stabilize communities. If the seller is a nonprofit or public agency, there might be some protections for buyers who miss a payment, but that’s not always the case.
“Credit has been tightening as interest rates and economic uncertainty have both increased, so qualifying for a loan is a shifting landscape,” says Greg McBride, CFA, Bankrate chief financial analyst. “Borrowers with weak credit histories or that lack a sufficient credit history are the most directly affected, though small business owners and borrowers lacking income documentation have been caught up as well.”
Because there is no traditional lender and no loan-related fees or closing costs, a land contract is a faster, cheaper process than getting a traditional purchase mortgage.
Instead of the buyer borrowing money from a lender, the seller finances the purchase of the house. The buyer and seller negotiate a contract that includes details such as the sale price of the house, interest rate, loan term, down payment and amount/cadence of the monthly or periodic payments.
After a few years of installment payments, the buyer often has to make a balloon payment, or a large lump sum payment. In addition, the buyer is usually responsible for paying for the home’s maintenance, insurance and property taxes.
In a traditional land contract, the seller retains legal ownership of the property until the buyer completes payment. In a wraparound land contract, however, the buyer immediately gains ownership through a warranty deed. In this case, the seller continues to pay their existing mortgage and keeps the difference between their mortgage payment and what they receive from the buyer each month. Such agreements must be approved by the seller’s mortgage lender.
A land contract is a financing agreement with terms that have been negotiated between a buyer and seller. As such, the provisions of a land contract can vary widely based on the situation, and aren’t subject to any conforming requirements or other criteria, like mortgages.
In contrast, mortgages are structured in standard ways (for example, a hybrid adjustable-rate mortgage or a 30-year term). They also come with a relatively predictable interest rate based on the market. With a land contract, the seller can set the rate at their discretion.
In addition, with a traditional land contract, the seller retains legal title to the property until the final payment is made and all conditions of the contract have been met. (This is not the case with a wraparound.) At that time, the buyer is usually responsible for filing the property deed with the new owner’s name with the appropriate government office. Prior to the final payment and title transfer, however, buyers can protect themselves by filing a “lis pendens,” or notice, with their local office. This serves as evidence of the land contract in the event a seller attempts to enter into contracts with more than one buyer.
It’s possible to convert a land contract into a conventional mortgage if the buyer meets qualifying criteria to get a loan from a traditional lender and seeks refinancing. Converting a land contract to a traditional mortgage could result in better loan conditions and can potentially eliminate the balloon payment commonly associated with a land contract. Refinancing requires getting a new mortgage and using the funds to repay the balance of the land contract.
The laws governing land contracts vary from state to state, and because buyers and sellers negotiate their own terms, each contract can be a little different. However, any land contract should lay out all the terms and responsibilities of both parties, including the following:
The National Consumer Law Center also recommends that a land contract contain requirements for an independent inspection of the property, including an estimated cost of repairs, and a third-party appraisal to verify the fair market value. This is mostly for the buyer’s protection. As the buyer, you should also enlist a title company to perform a title search, and obtain title insurance.
A land contract is not without risk, especially for the buyer, and laws governing their use vary by state. With this arrangement, it’s smart for the buyer and seller to each consult a real estate attorney to protect their interests.
One of the main risks of land contracts is the possibility of contract cancellation if a buyer fails to meet their obligations, such as making timely payments. This is in stark contrast to a more traditional mortgage, in which the loan is entered in the county public records and the borrower has a long time to pay down the principal balance. Land contracts often require a balloon payment to be made at the end of the contract, which can be a challenge for a buyer who doesn’t have the financial means to pay it.
The same contract cancellation risk applies to the seller, too, should the buyer default.
Unlike other contracts, with a traditional land contract the buyer does not automatically receive the title to the property. Instead, the seller holds the title until the buyer pays the entire contract price in full. This means the buyer cannot take out a loan against their equity or sell the property to a third party.
Unfortunately, it’s common for purchasers to forfeit their land contracts, which means they lose everything they’ve put into the home. They may still be responsible for the remaining balance, too, which can damage their credit.
Land contracts can provide an opportunity for individuals with poor credit or no credit history to purchase a house. However, they involve the seller, rather than a bank or lender, assessing the buyer’s creditworthiness. That means payments made on land contracts are typically not reported to credit agencies, so they do not help improve the buyer’s credit as on-time mortgage payments would.
Land contracts have advantages and disadvantages for both the buyer and the seller. Don’t sign one until you are fully aware of all the risks and have consulted a real estate attorney.
Land contracts offer an alternative to conventional mortgages, but they are risky, and there are other ways for those who can’t qualify for a mortgage to become homeowners. If you’re a first-time buyer, you might be eligible for a low- or no-down payment loan or other first-time buyer program instead, which offer assistance and grants to help cover some of the upfront costs of homeownership.
You might also decide to hold off on buying a home in order to work on your credit and save for the right moment. Check out Bankrate’s guides to improving your credit score and saving for a down payment to prepare for homeownership.
