Real Estate Seller Financing: The Difference Between Purchase Money Mortgages and Land Contracts
Article by Brian McMahon
Purchase Money Mortgages and Land Contracts are two methods of “Seller Financing” used in the sale of real estate. Seller Financing is most commonly used when a real estate buyer is unable to obtain financing from a financial institution, such as a credit union or a bank, because of credit issues for one reason or another (e.g. recent divorce, recent bankruptcy, etc.). The most common reasons a real estate seller would agree to Seller Financing are either because of a unique or personal relationship with the buyer (e.g. family member, etc.) or the seller has not been able to find a buyer who is interested in the property and qualifies for financing from a financial institution. It is important to note that Seller Financing may not be available if the seller already has a mortgage on the real estate that will not be paid off at the time of the sale to the buyer. The reason for this is that nearly all mortgages with financial institutions include a “due on transfer” clause requiring the immediate pay-off of the mortgage by the seller that would likely be triggered by the sale of the real estate to buyer.
A seller who agrees to transfer real estate using a Purchase Money Mortgage has effectively agreed to “act as the bank.” That is, the steps required by the seller to implement a Purchase Money Mortgage are the same as if a financial institution were involved. Like a transaction involving a financial institution, the buyer signs a promissory note and grants the seller a mortgage against the real estate being sold as the collateral. The remedy available to the seller in the event of a default by the buyer in this circumstance is the same as would be available to a financial institution. Namely, the seller has the right to “foreclose” on the mortgage. The foreclosure process is outside the scope of this article, but suffice it to say that it involves the filing of a complaint in the county where the property is located, obtaining a judgment against the buyer and the subsequent sale of the real estate at public auction. If the sale proceeds from the public auction are more than the amount of the judgment against the buyer, the buyer receives the excess sale proceeds. If the sale proceeds from the public auction are less than the amount of the judgment against the buyer, the seller can pursue the buyer for the “deficiency” using the normal methods of collection (e.g. garnishment of bank accounts, wages, etc.).
By contrast, the sale of real estate using a Land Contract does not include a promissory note or a mortgage. Instead, seller and buyer enter into a contract (i.e. a “Land Contract”) wherein the seller conveys “equitable title” to the buyer but keeps “legal title” to the real estate. The Land Contract will include a number of terms and conditions, not the least of which are that the buyer agrees to make payments and that the seller agrees to convey “legal title” to buyer once all of the terms and conditions of the Land Contract are satisfied. Like a Purchase Money Mortgage, one of the remedies available to the seller in the event of default is to file a foreclosure action. However, unlike a Purchase Money Mortgage seller, the Land Contract seller also has the option to file a “forfeiture action.” If successful in this action, the seller is allowed to keep the down payment and all payments made by the buyer as “rent.” In addition, the seller gets complete ownership of the property back without public sale.
Because of the additional remedy of forfeiture, I most commonly recommend the use of a Land Contract. However, regardless of which method of Seller Financing is used, it is very important that the seller obtain legal advice from a real estate attorney because of the various consumer financing laws involved and other risks of “acting as the bank."
Posted on December 09, 2014
Tagged as Real Estate