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.