A land contract is the appropriate document to use when the parties to a real estate transaction engage in seller financing. Here are five tips for making the experience easier for a land contract seller. The list is by no means exhaustive.
Make sure you provide your buyer with an amortization schedule. This way, both parties know where the payments stand in any given month. It has been my experience that when people are buying on land contracts, more often than not, they are newer to financing concepts such as the declining balance method. Having an amortization schedule shows how installment payments are allocated throughout the Michigan land contract relationship.
Tax and Insurance Escrow
I discourage sellers from collecting escrow payments for taxes or hazard insurance regarding a land contract. Instead, sellers should make it the responsibility of the buyer to confirm that property taxes and insurance are regularly paid. A buyer’s failure to pay taxes or insurance can be used as a separate non-monetary default to maintain a land contract forfeiture action.
One caveat: while it could be argued that the federal Dodd-Frank Act does not speak to escrow accounts in land contract agreements, if you are not an exempt seller under Dodd-Frank (selling your primary residence), there is a rebuttable presumption that the land contract terms are predatory. You should speak with a real estate attorney when it involves Dodd-Frank.
Michigan courts are clearly against prepayment penalties that exceed 1% of the land contract for more than three years. A higher prepayment penalty any longer than three years can place the seller in direct violation of the Michigan Consumer Protection Act, which allows the successful party in a lawsuit to collect their attorney fees.
Due-on-sale clauses create concern for sellers who have an underlying mortgage on their property. Briefly, bank and mortgage provisions generally preclude a seller from conveying their interest in a secured or pledged property without first paying off the mortgage —– thus the mortgage balance is said to be ‘due-on-sale” once the mortgagor conveys title to a third party. Whether selling a property on land contract actually triggers “due-on-sale” provisions is debatable, since the land contract purchaser does not actually obtain title until they pay off the contract. Memorandums of land contracts are recorded in the county to put the “world on notice” of a transaction. Still, it is not a deed which is the actual conveyance instrument.
Be advised that if you represent to a mortgage bank that you intended to use a property as a primary residence, and then shortly thereafter you sell it on a land contract for investment purposes, the lender could call the mortgage for misrepresentation.
Legal Remedies and Notice
Failure to specifically provide for the legal remedies available to a seller in case of a buyer’s default can make collection and eviction under a land contract a nightmare. In Michigan, the normal default process involves a forfeiture on the land contract. Land contract forfeiture actions do not allow for the seller to collect on monetary deficiencies, such as selling the home for less than what was owed by the buyer under contract. If a seller is seeking more damages over and above just the payments in arrears, they need to have a provision within the contract that calls for a foreclosure remedy. Notice provisions also need to be followed; otherwise declaring a contract default before the time allows can prove costly, a waste of legal efforts.
Unlike federal agency mortgages, which are nationally standardized documents, land contracts, more often than not, are drafted to meet the specific needs of the parties to a purchase transaction. Land contracts are legal agreements with far-reaching legal implications. They should be drafted and reviewed by a licensed real estate attorney.
David Soble has been in real estate and finance law for over 25 years and can be reached at 888.789.1715. If you find this article helpful, please share it.