Real Estate Land Contracts: FAQs

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Last week I wrote an article on the real estate investment strategy that my company focuses on: land contracts. This is a form of owner financing and to avoid repetitiveness, I won’t be going into the details of “what” it is and “how” it works. For that information, please check out my previous article here: Land Contracts: A Great Real Estate Investment Tool.

I wasn’t sure if there was much interest in the topic, but that unknown has now become clear. The comments section filled up with all sorts of comments and questions, so I wanted to do a follow-up article. I figured instead of answering all the questions in the comment sections (where it seems many tend not to look), I would just do a Frequently Asked Questions article, so here we are.

Does the Property Need to be Owned “Free and Clear” for a Land Contract to Work?

Yes and no.

Yes in the sense that if it is free and clear you can do whatever you want. If there is a mortgage on it, this is where you need to be careful. All mortgage’s have a “Due on Sale” clause, and because a land contract “is” technically a sale, you are in violation of this. Not the type of violation where you are going to jail, but a violation in the sense the bank “could” if they choose declare the entire balance due.

The best way to go about this is to be upfront with the bank and let them know what you are doing. The key is to GET IN WRITING that they will not call the balance due. You can do it without notifying them, but then you have to factor in the risk they could call the loan due. What are the odds of this? I would guess pretty darn low; however, that is a TOTAL GUESS on my part.

For me, I own them free and clear so I don’t need to take the extra step of talking with the bank.

Who Pays the Property Taxes and Insurance?

The buyer pays these. You can either have the buyer pay themselves, or set up an escrow where they include it in their monthly payment and then you pay each.

For me, I escrow the payments so I can rest assured property taxes are being paid and insurance is being kept on the house. On top of this, you will want to be sure the buyer adds you as the “Additionally Insured” on their home insurance policy.

What Do You Mean There is an “Extension” on Your Land Contracts?

All land contracts have a balloon payment. This is the period (usually 3-5 years for me) where the entire balance becomes due and at that time, the buyer must do a refinance with a traditional bank to “cash me out”. By “extension” I mean that if at the end of the balloon period, the buyer still can’t qualify for a traditional loan, you have the option to extend the contract for as long or short as you like. I want cash flow, so if my buyer pays on time and isn’t a headache, I’d rather collect interest for the next 30 years rather then get completely cashed out.

Point being, the “extension” is completely up to you and at your discretion.

Does the Buyer Assume the Loan or is it Subject To?

Neither. Well, sort of a “subject to”. At the end of the balloon period, the buyer does not assume the loan, they go out and refinance with a traditional bank (which at this current time in the market they WANT to do because they will get a much better interest rate) and get a new loan.

The legal title transfer is “subject to” the buyer paying off the entire balance of the land contract. When that happens, the deed transfers.

What if the Seller Can Not Be Contacted (Dies) After the Land Contract is Satisfied?

I’m not lawyer, but if all obligations of the land contract have been met, and the seller disappears or dies, I’m sure something from a legal standpoint would be done. I feel like this is sort of a needle in the haystack situation, but I guess it could happen.

As a buyer you should be tracking all the payments you make to the seller so in the event something like this happens, you have proof that you have indeed been making payments.

These questions pertain to ANY strategy in real estate though. ANY strategy is going to have “what if” situations that will cause lawyers to be involved.

Have I Ever Purchased on Land Contract?

I have not. I know some on BP purchase on land contract and I think it is a great strategy…. IF you can get the seller to give you good terms. This is my business, so an investor coming and trying to buy from me would never work because I’m not going to budge on what my terms are.

If it is just a normal seller, then you could probably talk them into favorable terms where you can make a deal out of it. Just be sure the seller checks with their bank (if there is a mortgage on the property) to ensure they are okay with it being sold on land contract.

How Does it Work if the House Needs Lots of Work so You Can Rent It Out?

Nothing changes. I’m sure the seller of the home would be thrilled to sell you their ugly house and then see you fix it up for them. Remember, from the seller’s perspective, you are fixing up a house where, if you default, they just get the property back. Wouldn’t be such a bad deal from their side of things.

The Equitable Interest Component Makes Things Risky if the Buyer Stops Paying?

Again, I’m not a lawyer, but land contracts are very common in the state of Michigan. So much so that the Realtor’s association I belong to has a standard boilerplate land contract apart of the paperwork they give you when you obtain your license.

Equitable interest or not, if you stop paying, you are BREAKING the contract. The land contract I use gives me two options when someone breaks the contract. I can either pursue a forfeiture route, or, a foreclosure route to take back the property.

Did I mention I’m not a lawyer? I will just say that the research I’ve done and people I’ve talked to make me very VERY VERY comfortable with doing land contracts.

What’s the Deal with the SAFT Act and Dodd-Frank?

Your interpretation is as good as mine. Just like I said above. With the research I’ve done and people I’ve talked with, I personally feel comfortable with how I am doing things. I’m not going to sit here and tell you “how” it is, because quite frankly, there is a lot of gray area with some stuff being voted into law and other stuff still “waiting”.

Your state government may look at things differently than Michigan, so all I can say on this point is, do your own research and networking and make the best conclusion you can.

My Lawyer / Title Company Says Land Contracts Are Risky – Are They?

I suppose that depends on the state you live in. As I’ve said, in Michigan they are very common place and I’ve used MULTIPLE title companies to close land contracts. Heck, I have NEVER had a title company say, “We don’t close land contracts.”

Is there is such thing as a “risk free” strategy? Of course not. That is why doing your homework and doing things the way they SHOULD be done is key. In the case of land contracts, screen and find a good buyer, and from the paperwork side, do things right… meaning, publicly record the land contract and all other appropriate paper work.

What Does the Fine Print of a Land Contract Say?

This really can’t be answered here. All I will say is a great phrase to Google is “land contract form” or “land contract template” or something of this nature. You will get all sorts of land contract forms that appear and you can read all the variations.

If you would like to see the one that the Realtor’s association I belong to includes in their standard paperwork, drop me a message and I’d be happy to email it to you.

I hope you found this helpful, and who knows, maybe this will create even more questions, but at the end of the day, this should be a great kick starter to help get you pointed in the right direction.

Photo: Voxphoto

About Author

Clay (G+) is a licensed real estate agent and the owner of Huber Property Group, LLC, a real estate investment company located in Grand Rapids, MI. His company purchases distressed properties with the main exit strategy of fixing them up and reselling with owner financing, particularly, land contracts.

20 Comments

  1. Great article on land contracts. I do know one investor friend of mine that did a land contract for 15 years (apartments) and then signed over the deed. Vs 3-5 years with a balloon. To possibly get around the due on sale clause you could put the property in a land trust, do what you want with in the trust (land contract) but also have the buyer be the benificial of the “trust” that just so happens to have the real estate in the trust. Hence avoiding triggering the due on sale clause.

    • Thanks Dale.

      That’s the great thing about the land contract. YOU are the boss, so whether you want to do 15 years or 3 years, or heck, 6 months, that’s all YOUR choice.

      Interesting idea about the land trust thing. I’m not a lawyer so I have no idea if that would work or not, but no doubt pretty darn interesting.

  2. The Department of Housing And Urban Development (“HUD”) issued a final rule for the Secure and Fair Enforcement for Mortgage Licensing Act (“S.A.F.E. Act”), effective August 29, 2011. This article summarizes a few key sections of the new rules for the real estate community. This article is not a substitute for legal advice from a knowledgeable licensed attorney.

    Background:

    Real estate investors, brokers and other industry participants have repeatedly sought confirmation that they can engage in activities or transactions that are prohibited by the SAFE Act or other laws.
    Neither wishful thinking nor hiding one’s head in the sand can change law or make prohibited activities lawful. Attempts to interpret the SAFE Act and the Michigan Mortgage Loan Originator Licensing Act (MLOLA) sections applicable to Land Contracts have been complicated by a disjointed law-making process, multiple sets of federal and state laws, the involvement of multiple state and federal governmental agencies, different and sometimes conflicting rules and regulations.

    To make matters worse, purveyors of the legal equivalent of “snake oil” are offering real estate training based on land contracts. These “legal gurus” and their disciples have spread bad information to the real estate community.

    Combine wishful thinking, bad advice from both non-lawyers and lawyers and the confusing law-making process by state and federal agencies, and the result is incomprehension and non-compliance.

    Even well-intentioned, knowledgeable, ethical persons, those who always follow the law (and some who even teach the law), have been stumped in their efforts to navigate through this bewildering maze.

    Many Land Contracts Are Covered as of August 29, 2011

    Many real estate investors have relied on outdated guidance that land contracts are not regulated by the SAFE Act. That is now untrue. There are circumstances when a land contract might not be subject to the SAFE Act, but the presumption is that land contracts, also known as “installment sales agreements,” are subject to the SAFE Act. A significant portion of the public comments submitted on HUD’s proposed SAFE Act rules pertain to the issue of a property owner selling and financing the sale of his or her own property. Whether an owner sells a property using a deed and “take-back” mortgage, or a land contract, the transaction is subject to the new rules. The HUD rules clarify that a land contract is a “residential mortgage loan” under the SAFE Act.

    The HUD SAFE Act Rule states in part:

    As an initial statement, HUD confirms the commenters’ observation that a ‘‘residential mortgage loan’’ includes an installment sales contract, which the commenters advise is frequently involved in seller financing. ‘‘Residential mortgage loans,’’ as defined by section 1503(8) of the SAFE Act, refers to typical financing mechanisms such as mortgages and deeds of trusts. In addition, the SAFE Act definition also includes ‘‘other equivalent consensual security interest on a dwelling (as the term ‘dwelling’ is defined by section 103(v) of TILA) or residential real estate upon which is constructed or intended to be constructed a dwelling,’’ which has the potential for including a broad range of other financing mechanisms. For the purposes of this rule, ‘‘equivalent consensual security interests’’ specifically include installment sales contracts, consistent with the treatment by many states of such contracts in the same manner as mortgages and purchase money mortgages offered by sellers of residential real estate. While there is no formal recorded lien held by the provider of financing, the fact that the seller holds title to the property until the contract has been paid in full is the practical equivalent of a lien for purposes of the SAFE Act and its purposes and is comparable to the status of a mortgage in a state that follows title theory under mortgage law.

    Accordingly, many Land Contracts are subject to the new rules, despite prior information to the contrary.

  3. Steve Johnson on

    I was just at a meeting with some investors doing a panel discussion. Subject-to stuff came up and I specifically asked how do you protect yourself from the DOS clause? I was given the very confident answer that they all put their properties in a land trust with a beneficiary who is perhaps out of state, or better yet in China. By law, to demand a beneficiary to fess up on who is involved with the trust they have to personally be subpoenaed, and if they are hard to get to the chances of pursuing that person are much smaller. They guys all testified that they’ve never had a DOS using this strategy (knock on wood). I’m curious, what is others take on this specific strategy?

    • I am also not a lawyer and I also have not done anything like this, so that is my disclaimer…

      I THINK that in this strategy you mean the Trustee not the beneficiary. My understanding from reading and talking with my attorney, and doing one trust that was not for holding title to real estate, that the beneficiaries are not public, the only thing that is recorded is the name of the trust and the trustee (i.e. the person or entity that has the signing authority).

      I have heard the idea of making it harder to track thing back to you and/or your company by having the Trustee be a trusted party that lives out of state and at least has a different last name. For example I am planning on putting some rentals in Trust and having the beneficiary be a new LLC to separate these from other business and holdings. I will ask my sister in law that has a married name and lives over 1000 miles from the property.
      She will then sign a contract to do all the management with my management LLC and I have full control over the day to day operations (which I can subcontract out if desired).

      FYI my understanding is that putting a property in Trust is an exception to the DOS because people will do that for estate planning purposes without transferring title to someone else as the beneficiaries.

  4. I’ve sold many properties I bought sub2 and other ways on Contract for Deed/CD (a more common name for Land Contract) with no Due on Sale problems at all. I’ve bought properties on CD and resold them on CD with no DOS problems at all. I never push the issue with a bank–obviously–and don’t worry about it and neither should you. One guy I heard about once who claimed his lender threatened to invoke DOS just kept making payments and never heard from them again.

    The “what if your seller dies” question is a good one. Best to plan to settle up with them within, say, at least 3-5 years, sooner if you can. One strategy I like to use is to contact them a few years in, offer to buy them out for cash, but less than is actually still owed. Some sellers have contacted me and been happy with as little as 20c on the dollar. They needed the cash more than the payment. I can always find cash to buy down debt that much! Also, if a contract due run to term and it’s almost fully paid (it’s happening now with some properties I bought at 0% interest from motivated sellers), call them with the balance in hand about 6 months before it’s paid in full, a nice final check is a nice incentive to get them to meet you at the title company for the final satisfaction of the contract.

    The SAFE act, and various state laws (including a new one in Minnesota) seek to regulate private contracts, discouraging people from selling that way, and effectively killing off home ownership for someone with marginal credit. As usual, the govt passes laws they think will help people, but ends up hurting them. Maybe that’s part of Obama’s strategy, keep people down, poor, feeling victimized, voting Dem, and renting forever.

    • While you (or people you’ve talked to) may have never had a problem with the due on sale issue, that doesn’t mean it is non existent.

      I myself have never heard of a bank calling the note due, but they COULD if they wanted to, and that’s the point that needs to be kept in mind.

      To say there is zero risk is false. While the risk may be tiny, it “is” still a risk nonetheless.

  5. Great Article Clay,
    I have a property that has been on a land contract for 2 yrs now. I was considering selling the note, but I was told that it was impossible due to the land contract on record. My response was “banks do it all the time”..I’m still researching but like to get opinions here. Also, is there any creative ways that you’ve used to help buyers get financing and how do you approach the buyer & prospective bank. I have a considerable amount of equity in this property and I’d like to use it for other deals today.

    Thanks!
    SA.

    • I have no idea why the land contract being recorded (as it should be) would present an issue for a note buyer. Perhaps a note buyer could comment on this?

      There isn’t much you can do to help them get financing. It’s all about them getting their credit fixed back up, and while you can point them to credit repair people, at the end of the day, it is on their shoulders.

  6. Clay, I never said the chance of DOS being invoked was zero. Neither is the chance you’ll get hit by lighting or a falling jetliner today. I’d prefer to focus on what makes me money, not on what minutiae might possibly derail me.

    • I never meant to imply that stated it had zero chance, my apologies if that is how you took it.

      Everyone has different risks levels that they can psychology withstand. What you might consider “minutiae”, someone else may consider much more.

      My point is that each individual investor needs to at least be aware of the due on sales aspect, and then they can “evaluate” what category of risks they want to put it in.

  7. Q Is it a violation of the law for an owner to try to circumvent the due-on-sale clause by having the purchaser or optionee or lessee not record the instrument reflecting the transfer?

    A Maybe. Triggering a due-on-sale clause is not illegal, but concealing the fact that such a clause has been triggered could possibly be a violation of of both federal and state law. Persons who have been prosecuted in mortgage matters are typically charged with one or more of the following federal felonies:

    false statement on a HUD loan (18 U.S.C.§ 1012);
    false statement on a conventional loan (18 U.S.C.§ 1014);
    mail fraud (18 U.S.C.§ 1341);
    concealment (18 U.S.C.§ 1001);
    conspiracy (18 U.S.C.§ 371);
    racketeering (18 U.S.C.§ 1961)

  8. I’m renting a house right now, and possibly going into a land contract. Will all the money I have put in (rent over the last almost 3 years including the deposit) be applied to the contract?

  9. Congrats on getting your loan (or winning the lottery) lined up to buy your home. Unlikely all the rent you’ve paid will be credited, though. Maybe none will. Check your paperwork. Some new laws passed by Congress recently have discouraged and even forbidden sellers to give any rent credit at all. Sad when Washington has to mess up a good thing.

  10. On a commercial land contract can the seller put pre-payment terms that buyer must maintain contract for a minimum of 3-5 years and the payment stays the same based on amortization regardless of extra principal payments made? Is this enforceable in court should buyer attempt to payoff contract within minimum period? I am trying to sell my family store and I am given a low price, so I am hoping to compensate the selling price by ensuring that buyer maintain the land contract for 3-5 years in order to accumulate interest and cut my losses short…

  11. Cody Steck

    What are the risks for a buyer on a contract for deed? I understand that in contract for deed, if the buyer defaults, it is treated as a glorified lease option, as opposed to a trust deed where it would be treated as a foreclosure. What other risks could the buyer face? Can the buyer still sell the property if the due on sale clause is triggered or the buyer becomes distressed?

  12. Scott Pigman

    I realize I’m late to this party but here’s hoping that Clay will still respond:

    Clay, a couple questions. First, have you ever actually gotten a statement in writing that a bank won’t invoke their rights under the due on sale clause, or don’t you deal with properties with an underlying mortgage? I’ve seen and heard a lot of discussion about the due on sale clause but this is the first I’ve heard that a bank may be willing to give up that right.

    Second, I’m just curious if mortgage wraps, which are a popular strategy here in Texas, are done or possible in Michigan. Down here I’ve never heard of anyone doing something like a land contract. I believe they would be considered a form of option period. I forget the exact details but Texas law makes it very unattractive to do options for longer than six months so no one uses them as an exit strategy. Instead what investors do when there’s an underlying mortgage is draw up a contract with the owner that transfers title in exchange for making the seller’s payments and then sell the property with owner financing to a new buyer. An investor will typically offer terms of $10-20K down, 7-8% interest and a five year balloon. There are a lot of people here who are paid in cash, don’t have bank accounts, and can’t get a traditional mortgage who are willing to accept terms like that. The investor collects payments from the new owners, pays the original owner’s underlying mortgage, and pockets the difference. Is there any reason why that wouldn’t work in Michigan?

  13. April D.

    Hello Clay,

    You mentioned in this article that you would be happy to email what your Realtor’s association includes in their standard paperwork for land contracts in Michigan. I would really appreciate this info as I just bought a house at a tax sale in Battle Creek, MI and may sell it on a land contract.

    Not sure how to message you other than posting here.

    Thanks,
    April

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