Land contracts are a less-common and lesser-known type of real estate transaction. What are they, why are they used, and what are some of the considerations involved?
Background and Nature
Land contracts are the “rent-to-own” of real estate. They are a mechanism for a property owner to finance the sale of their own land. In most conventional land sales, the buyer either pays cash or obtains a commercial mortgage, the seller conveys title by a deed immediately, and then the seller exits the transaction. Conversely, in a land contract, the seller (“Vendor”) and buyer (“Vendee”) sign a contract for installment payments; the buyer pays directly to the seller, and then the seller conveys title by a deed when the payments are complete. The seller remains involved the entire time. During the contract term, the seller remains the record and legal owner of the property, while the buyer becomes an equitable owner – having the right to obtain title to the property by paying the full purchase price.
Reasons for Use
The most common reason to use a land contract is when the buyer cannot qualify for a conventional mortgage, or could qualify only with an unfavorable interest rate or terms. The buyer may have poor credit, a recent bankruptcy, or irregular income. A seller may have better knowledge or a greater comfort level with the buyer than a commercial lender. For this reason, land contract buyers are often current long-term tenants of the seller. A seller may also want to avoid paying commission for a traditional real estate listing, or may prefer a steady stream of income to a one-time lump sum, such as in retirement.
Initiating the Transaction
The land contract will specify the payment schedule and interest rate. The interest rate may not exceed 11%. Amortized monthly payments are most common, like mortgages. The land contract will also specify the duration of the payments. A land contract may have a term of 15 or 30 years like a conventional mortgage, or it may balloon after 3 or 5 years. Because land contract sellers are typically individuals or family companies, and not large corporations, shorter terms are more common. In the case of a balloon structure, the buyer must renegotiate the terms or obtain a conventional mortgage on the balloon date. In the time since the original transaction, either the buyer’s credit or lending interest rates may have improved. The land contract may contain provisions regarding acceleration, forfeiture, and foreclosure.
The land contract will also specify who will be responsible for maintenance, property taxes, and insurance. Typically, the buyer will take over all three, as they would with a traditional sale. The buyer must file a Property Transfer Affidavit with the local tax assessor within 45 days after signing the contract. The buyer’s insurance should also name the seller as an additional named insured party.
Protecting the Buyer’s Interest
The buyer may protect their interest by recording either the full land contract or a memorandum of land contract with the country register of deeds. Many sellers and buyers do not want the full payment terms to be public record. For this reason, it is sufficient to record a memorandum of land contract. The memorandum documents the date that the seller and buyer signed the land, and states that the buyer obtained an equitable right to ownership. This gives notice to the public of the buyer’s interest, and prevents the seller from either selling or mortgaging the property in conflict with the buyer’s rights.
Particularly with longer payments terms, the seller may die before the buyer completes the land contract. For this reason, the buyer should insist that the seller execute the final deed at the same time as the land contract. Even when the seller executes the deed in advance, it may be lost over the intervening years. Therefore, it is in the buyer’s best interest to have the deed escrowed with a title company or other responsible party. Then the buyer can obtain a deed upon proving full payment of the land contract, even if the seller can no longer execute a deed.
Protecting the Seller’s Interest
The seller will need to continue to monitor the property to ensure that the buyer is not committing municipal ordinance violations that could cause could result in fines. The seller will need to ensure that the buyer keeps current on the property taxes, and be ready to step in to avoid tax forfeiture. The seller will need to ensure that the buyer keeps current insurance on the property, to avoid possible liability exposure. If the property is legally a condominium, then Michigan law makes the seller and buyer jointly responsible for association assessments. The seller will need to ensure the buyer stays current on the assessments, to avoid a lien from the condominium association.
If the seller defaults by failing to keep up the payments or other breaches, and the contract contains a forfeiture clause, then the seller may pursue forfeiture. The seller must send the buyer a forfeiture notice stating the missed payments or other breaches, and giving the buyer 15 days to catch up the payments or correct and cure the breach. If the buyer fails to cure, then the seller can sue in district court for forfeiture. If the seller successful in court, then the buyer must forfeit all the money paid under the contract to the seller, and the seller can retain ownership of the property. Even after the judgment, the buyer has a redemption period to pay before facing eviction. If the buyer has paid less than 50% of the full purchase price, then the redemption period is 90 days. If the seller has paid 50% or more of the full purchase price, then the redemption period is six months.
If the land contract does not contain a forfeiture clause, then the seller can sue in circuit court for foreclosure. This process results in the property going to a Sheriff’s sale, where third parties will have the option to bid on the property. Foreclosure also has a redemption period, which will normally be six months. The seller may also choose foreclosure if the land contract contains an acceleration clause, making the full purchase price due immediately upon default, and the seller believes the buyer has the money to pay a judgment for the full value.
If the seller defaults by failing to deliver a deed once the buyer pays the full purchase price, then the buyer may have to sue the seller in a quiet title action. The complaint asks the circuit court to find that the buyer has fulfilled the land contract and is now the legal owner.
It is essential for both the seller and buyer to maintain accurate records of payments, and maintain receipts. This is necessary to facilitate reconciliation calculations at the end of the contract term, or in the event of default.
Are you considering buying or selling property using a land contract? Do you have a problem with an existing land contract? We at Tilchin & Hall, P.C. are available to advise you regarding drafting, execution, administration and enforcement. Please reach out to us at (248) 349-6203 or email us using the form below.
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