Land contracts provide a way to buy and sell real estate without involving a bank. However, buyer and seller need to understand exactly what they’re agreeing to.

Have you ever wondered what a land contract is and how it works? Here’s a quick overview to help you understand the basics.

Land contracts in a nutshell

Land contracts are a financial and legal tool used to buy and sell real estate. The purchase could include vacant land or property with a home and/or other buildings.

The terms of the sale are agreed to by the buyer and the seller and committed to writing in the land contract. Terms—which include but are not limited to price, down payment, payment period and interest rate—are all negotiable.

A land contract is legally binding so it’s a good idea to work with an experienced real estate attorney whether you’re the buyer or the seller.

How land contracts work

In simple terms, the seller becomes the lender. The buyer makes a down payment and promises to make payments for an agreed upon period. Often, installment payments are made for three to five years; then a balloon payment for the balance is due. When the balloon payment is due, the buyer may pay it in cash or get a mortgage through a bank.

The property’s title doesn’t transfer to the buyer until the terms of the contract are completed. However, a land contract usually allows the buyer to use the property while making payments to the owner.

Who uses land contracts

Buyers who use land contracts either prefer not to work with a bank or don’t qualify for a mortgage because of a poor credit history, a previous foreclosure, bankruptcy or other reasons.

Sellers who use land contracts may have a unique property that doesn’t conform to lender’s standards. For example, it may need repairs. Sometimes sellers can get a higher sales price with a land contract versus a conventional sale. And, some sellers find land contracts advantageous because it allows them to defer taxes on gains.

Pros of a land contract

Land contracts appeal to some buyers because they aren’t required to pay all the fees associated with a traditional loan, like appraisal fees and closing costs. However, many buyers still get an appraisal and purchase title insurance.

Also, a land contract transaction can be completed quickly, sometimes in less than a week.

Cons of a land contract

In a land contract deal, the buyer doesn’t gain any equity in or title to the property until the terms of the contract are fulfilled. This means there is substantial risk for the buyers if they default on the contract or fail to make installment payments. In these cases, the seller can proceed with legal action that may result in the buyer forfeiting any funds paid to the seller, including the down payment. Depending on the terms of the contract, the seller might be able to keep the down payment, all the installment payments and the property.

Sellers can breach the land contract, too. In some cases, sellers refuse to transfer the property title to buyers when the contract is paid off. To resolve an issue like this, the buyer will initiate legal action.

Get professional advice if you get a land contract

Does a land contract make sense? In some cases, yes. If a land contract is an option you’d like explore, we suggest that you talk with an experienced real estate attorney. Make sure you understand all the terms, and what happens if either the buyer or seller doesn’t hold up their end of the land contract.

For more information on land contracts, view this information from Sun Title.

Consumers helps thousands of members finance land, first and second homes, and home improvement projects each year. We’d love to help you with a mortgage or home equity line of credit; contact us online or call us at 800-991-2221.