The Benefits and Pitfalls of Real Estate Land Contracts
A land contract can be an attractive alternative to a traditional real estate transaction. Unlike a conventionally financed purchase of property, third-party lenders are not involved in a land contract – the agreement is solely between the buyer and the seller. Despite several valuable benefits for both buyers and sellers, however, land contracts also have disadvantages and risks.
Land Contracts 101
A land contract is drafted by the seller, who usually acts as his or her own real estate agent. The agreement explains the parties’ rights and responsibilities and sets forth an installment payment plan, and how property taxes, insurance, and any other issues will be handled.
Perhaps the most significant distinction between a land contract and a mortgaged real estate purchase is that the seller does not immediately transfer the deed. Instead, the buyer receives the deed to the property when the final payment under the contract is made.
The Upside of Land Contracts
Simplicity, efficiency, and lack of formality are among the chief reasons parties to a real estate deal might consider a land contract.
Consider the ease of the transaction. Because a bank or third-party lender is not involved, the seller is largely in control of the contract and can impose his or her own terms of sale, assess the buyer’s creditworthiness, establish the down payment, and determine the interest rate. The seller can set payments that fit within the buyer’s budget, and the deal can close within a matter of days, if not hours. When issues arise, they are often more easily addressed than a traditional real estate transaction. Unlike bank foreclosures, a land contract dispute can be settled in as little as 90 days.
There are also tax and income benefits. A seller can avoid paying capital gains tax all at once, and the taxable income is spread over several years, rather than in the year of sale. The seller may realize a greater overall profit through a higher interest rate, and real estate investors may gain control of property with little or no cash, then sell the property (at a higher price) or turn it into rental income.
A land contract lets the seller enjoy a steady cash flow without the hassles of managing it as rental property, and also offers an asset or equity interest in exchange for other property. For example, an agreement may say: “I will give you my two-unit rental property at 123 Spring Street and a land contract in exchange for your single-family residence at 678 Main Street.”
Land Contract Dangers and Risks
There are negative aspects of land contracts, so buyer beware.
If holding the title is important to a purchaser, a land contract is not an appropriate option; title does not automatically pass to the buyer in a land contract deal. Similarly, because the seller generally retains the title until the final payment is made, local authorities and inspection departments could hold the seller liable for any maintenance problems that arise with the property.
Forfeiture is another major consideration. The seller should always know where the buyer is physically located because if the buyer defaults and the seller has to initiate forfeiture proceedings for nonpayment or another issue, the complaint must be delivered to the buyer by personal service. Once the seller serves the Notice of Forfeiture, the purchaser can usually cure the default within 15 days before the seller can sue to forfeit the land contract.
Once the court enters a judgment, there is usually a three-month redemption period in which the buyer may redeem the property by paying the amount due on the complaint, but the payments under the land contract may still be in arrears by three months (the payments that will have accrued during the forfeiture period). Michigan courts have limited the damages that sellers can request in forfeiture proceedings, whether in the form of the property or money, depending on how the remedy is determined and enforced.
Land contracts do not preclude mortgages. They often include a clause that permits the seller to obtain a mortgage up to the contract balance and if the seller defaults, the buyer can assume the mortgage payments. The buyer, however, rarely learns of any default until there has been an acceleration and foreclosure, and the buyer would still have redemption rights against the mortgage holder.
If you are considering a land contract to purchase or sell property, please contact the experienced real estate attorneys at Kreis Enderle with any questions.