The American Education Institute

ENTER A PURCHASE OR LAND CONTRACT AGREEMENT TO BUY PROPERTY.

What this boils down to is an installment agreement similar to the types of installment financing you might use in buying most any valuable item at retail.  It is fairly common in some states, but almost completely unknown in others.  It is commonly called a “land contract” because it’s used most often when buying vacant land, but it certainly also applies to improved land as well.  Basically what this type of contract in real estate does is require the purchaser to pay all of most of the balance due on a property before even the title is transferred.  Almost like buying a car, the financier of your purchase won’t give you the car’s title until you pay off the debt.

In real estate, of course, you have both a title and a deed.  In a land contract simplest form, you don’t get title until an agreed amount of the full price has been paid and you don’t get the deed until that price has been completely paid.  Again, as in the previous method, entering into such a contract as this almost always involves seller financing.

In theory, a land contract gives the seller some protection in case the purchaser defaults. It actually gives greater protection to the seller, but also requires greater risk on the part of the seller.  A land contract will stipulate that if the purchaser fails to make payments as required, whatever money he has paid will thus be considered “rent” from the date of closing to the date of default.  In effect, this means that the seller hasn’t yet sold anything;  he has merely been the landlord.

But to protect that seller’s interests, land contracts usually — and should — require that the purchaser file a “quit claim deed” with the seller (usually held in escrow by the title, or title insurance, company or some other appropriate third party) and this should be done at closing.  This is most especially true if the land contract itself, or “affidavit and memorandum of agreement” or “articles of agreement for warrant deed” or some other such legal document, has been filed with the county recorder of deeds or governing public records office.  That this does, in effect, is guarantee to all parties concerned that, if the purchaser defaults, property ownership reverts to the seller.

Land contracts always specify whatever exact dollar payments are required.  You can generally count on these being the specific monthly payments that you as the buyer will be required to make.  These contracts will further specify that, for each payment, money is first applied to pay interest on the loan amount; secondly to specific charges like real estate taxes, property insurance, and any special assessments; and only thirdly to the outstanding principal balance.  Further, a land contract may specify exactly when, how, and for how long such payments will need to be made before title to the real estate is transferred to the purchaser.  Generally, if legal title passes before the loan if fully paid, the contract will specify a “balloon” type final payment that will come due on a specified date.  A balloon payment usually means “payment in full”  of the entire remaining balance.  But the contract could  also specify that a in lieu of such balloon payment, the seller can simply take back the mortgage and resume ownership of the property.

It isn’t actually true that land contract sales give a legal way to bypass the term known as “due-upon-sale” which is found in many mortgages.  This is not true because a due-upon-sale clause is effected by any transfer of legal or equitable title to real estate.  It may well be that the transfer of legal title is delayed by the provisions of a land contract, but in the eyes of the law equitable title has indeed passed to the purchaser.  And in actual practice, however, this due-upon-sale clause is only invoked with the transfer and recording of a deed, and such things as property insurance, for example, will continue in the name of the seller and not the purchaser.

It is actually possible for a purchaser to borrow from a lender to buy property on a land contract, and that lender would not know this because no deed was recorded showing any change of ownership.  Deed are public record, remember, and anyone who wants or need to know such things can easily find out exactly what properties you do own — but not what properties you happen to be buying but don’t own yet.

IT’S THE LAW

What all this means that ownership remains with the seller until he has been completely paid for his property.  If a traditional lender makes a mortgage, that lender does in fact pay off the seller completely and that property deed is transferred to that lender.  In most states, it is title to the property that passes to the purchaser.  A deed to real estate is never conveyed to a purchaser until all payments have been satisfied.  If you have a mortgaged property, you do not have the deed to that property.

Here is a practical example of a land contract deal that enables a purchase with 100% financing.  Suppose you find a two-family duplex with an asking price of $75,000.  The property has an existing non-assumable mortgage of $40,000 that requires a monthly payment of $350.  The seller wants a cash down payment of $7,500.  He is also willing to agree to a wraparound mortgage for $67,500 at 9% interest.  Suppose further that the seller is getting a little desperate and you are able to talk him down to a sale price of $70,000.

You do not, however, want the deed to be recorded with a new lender because this would trigger the due-upon-sale clause forcing the first mortgage to be paid in full.  You want only to deal with this seller who has already agreed to help your financing by means or a wraparound mortgage.  You want to make payments only to him, and he will in turn continue to pay the first mortgagee — making a slight profit for himself with each payment.  So now assume you are able to negotiate a land contract sale.  In exchange for his keeping title and his first mortgagee keeping the deed — which, you tell him, puts you at greater risk — you are now able to get him to reduce his required down payment to just $3,000.  Furthermore, you get him to accept this over the course of three years, at two semiannual payments each of $500 and at 0% interest.

The remaining balance of $67,000 will be paid through terms of the land contract at an 8% rate of interest.  After five years, you agree to take title to the property from him.  Meanwhile your monthly payments to him are going to be %580, calculated to be broken down and specified to be allocated like this:  $447 for principal and interest, and $133 for insurance and taxes.  Recall that his full monthly payment is $350 (plus the hazard insurance and real estate taxes).  So at the very least, this seller will be making a profit each month of $97.

But you also know that renting out both family units in the duplex will bring income of $900 per month.  Even if you add, say, a 10% ($90) management fee and $80 a month for maintenance on top of your $580 monthly expense ($90 + $80 + $580 = $750), you will be earning a profit yourself each month of $150 ($900 – $750 = $150).  This is what’s called a positive cash flow.

Obviously, this agreement is win/win for both the seller and the buyer.  Your initial cash outlay under these terms if $500.  And yet you  acquire a property that will net you $150 per month.  On the other side, the seller has the security of retaining title and leaving the financing right like it is.  The first mortgagor retains the deed.  And on top of all this,  the seller himself make nearly $100 profit per month!  This there’s a positive cash flow for both parties concerned.

But, of course, there are cautions to this that you need to be aware of.  If you enter into a land contract agreement extending for many years, perhaps 10 to 15 or longer, there are some possible events that could happen which would put you in a bad position.  For example, if that original mortgage contained the due-upon-sale clause, the longer your land contract deal extends, the longer that lender has to discover this “sale” and thereupon call the mortgage due and payable immediately. Of course, the longer the time, the less will be due, and you may well be able by that time to afford the risk.  Or, you might also at that time be able to refinance conveniently and pay off that first mortgage without much hardship.  Or, by that time the original lender might even let you assume the mortgage (no doubt for higher interest or less attractive terms) but by then you might be able to afford this.  But to safeguard against this, it is always prudent to decide ahead of time how you and the seller will handle this if the original lender calls in the loan.  Stipulate your agreement right in the land contract itself.  A reasonable stipulation would be for you both to agree to split whatever cost increases might arise from such a forced refinancing arrangement.

Another important consideration to spell out on the land contract is exactly who should be the recipient of any insurance damage claims or proceeds from condemnation.  In other words, you need to state in advance what will happen if the duplex burns down.  It would also be prudent to spell out what should happen during the term of your contract if the seller were to divorce, die, go bankrupt, become seriously ill, or even mentally incompetent.  Generally, you can protect yourself by stipulating that the seller execute a “quit claim deed” of his own, which would also be held by the same “arms-length” third party that holds your “quit claim deed” to him.  Finally, whenever the payment terms of your land contract are satisfied, the agreement should specify exactly how the deed is to be conveyed to you as the new owner.

One more consideration might be how to guarantee that this seller will in fact actually continue to make his monthly payments to the original mortgage lender.  It might be best actually to have the same third party that holds your quit claim deeds receive and process all payments. Or, you might possibly agree to have a lawyer do this.  But whatever you agree, be sure it’s in writing and included as part of the legal land contract agreement itself.

Lastly, be sure a title search is done on the property before you enter into any land contract purchase agreement with the seller.  You want to be guaranteed that title to the property is in fact “clear.”  This means:  no other outstanding loans (for example, home equity loans), no liens, and no encumbrances of any kind.  To ultimately protect yourself, you might consider recording the land contract itself (or “memorandum” of such) with the county recorder or public records office.  The only risk here, of course, is that such is public and that original mortgage lender can easily discover this and call that loan due a lot sooner than either you or the seller might expect.

So as a final thought, be creative in your financing, but also be cautious in your dealings with people you may not always be able to trust.  Being a skeptic is much better than being a victim.

This land, or purchase, contract method for obtaining 100% financing (or very close) is summarized in the following chart.

METHOD NUMBER 19 IN BRIEF

What it is designed to do:

• Enter a purchase or land contract agreement to buy property

What you need:

• Flexible seller who doesn’t seriously need cash at closing, who is more interested in monthly income and positive cash flow, and who may also be concerned about loan security.

What your terms are:

1.  Property asking price                                $75,000

2.  Present mortgage                                       $40,000

3.  Present payment per month                 $        350

4.  Equity to seller                                           $35,000

How you proceed:

1.  Negotiate a land contract agreement based on a sale price of $70,000

2.  Negotiate with the seller to accept $3,000 as down payment, but payable in six semiannual installments of $500 at no interest

3.  Negotiate the contract agreement on the remaining balance of $67,000 at 8% interest with P&I payments of $447 with title passing after five years

4.  Agree to monthly tax and insurance payments corresponding to seller’s own at $133 (added to $447 equals $580).

What the seller can expect:

• Seller gets some money up front, a monthly income producing a positive cash flow, a very well secured loan upsetting none of his present arrangements, and a property sale realizing approximately 92% of his original asking price.

What you the buyer can expect:

• You have secured a “mortgage” even without establishing any credit whatsoever.
• You have negotiated an investment resulting in a $150 positive cash flow each and every month, even after paying additional management and maintenance fees, and you don’t have to occupy the premises personally.
• You have acquired an income-producing property for almost entirely 100% financing.  In fact, if you collect rents and security deposits at closing (that is, have no vacancies), you’ll walk away from the deal with money in your pocket!

100% Financing When Buying Real Estate / Dr. Eric T. Martin / 3-21-10