A land contract is a written legal contract or an agreement and it’s used to purchase real estate, such as a house, an apartment building, a commercial building, or even vacant land, so long as it deals with real property. Buying or selling on a “land contract” in Michigan is a transaction involving seller financing. It’s similar to a mortgage, but rather than borrowing money from a lender or a bank to buy real estate, the buyer makes the payments to the real estate owner or the seller until the purchase price that was agreed upon between the parties is paid in full. A buyer and seller both signed the land contract and that land contract covers certain provisions in the terms and conditions of the sale and when those terms are satisfied and all the conditions are met, including payment of the purchase price over a certain period, then the legal title of the property transfers from the seller to the buyer by way of a deed.
It can be a warranty deed or it can be a quitclaim deed, whatever the parties negotiate.
So why are land contracts used when mortgages are so freely available? Well, land contracts are a form of seller financing and as stated, you know, there’s certain advantages to both buyer and seller. With a buyer, the buyer may not have the greatest credit or they may have some income issues or some other reasons that prevent them from being able to obtain a mortgage from a traditional bank or mortgage lender. Therefore, the parties can enter a sale by land contract so that the buyer makes monthly payments directly to the seller. Regarding the seller, the land contract benefits them because it can create a monthly income stream. If there is no underlying mortgage or encumbrance, the seller is going to be getting cash on a regular monthly payment.
The seller can also get a higher purchase price, usually from a buyer, because the buyer is at a little disadvantage. The seller can ask for a higher purchase price. The seller may also require a larger cash down payment and that can be used to generate income. Having a land contract is an appropriate document to use when the parties to a real estate transaction deal in seller financing. There are a few things that I like to look for to make things easier for both buyers and sellers on a land contract. Let me just share with you, these five, but there are more.
- The first is an amortization schedule. You know, the parties need to make sure that they have an amortization schedule attached to the land contract. This way, both parties know where the payments stand in any given month regarding payments. It’s been my experience that when people are buying on a land contract, more often than not, they’re newer to financing concepts such as the declining balance method and therefore having an amortization schedule clearly shows how installment payments are allocated throughout the Michigan land contract relationship.
The next provision that should be looked at is tax and insurance escrows—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 their property taxes and insurance are paid regularly. 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.
- There’s one caveat and it can be argued that under the federal law, called Dodd Frank, that the act does not speak to escrow accounts and land contract agreements. So if you’re not an exempt seller under Dodd Frank, that means if you’re not selling your primary residence, then there is a presumption that the land contract terms are predatory. So you should really speak with a real estate attorney — a competent real estate attorney when it involves Dodd Frank and when it involves a real estate investment property that you’re selling on a land contract.
- The third provision deals with prepayment penalties. Michigan courts are clear against prepayment penalties that exceed one percent of the land contract balance for anything over three years. So within three years, the first three years, the Michigan Consumer Protection Act allows parties to collect a prepayment penalty; after that, the buyer could sue the seller for predatory lending. So be very careful there. See an attorney.
- Due-on-sale clauses create a 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 secured or pledge 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. So whether a seller selling a property on a land contract actually triggers due-on-sale provisions is debatable, since the land contract purchaser does not obtain title until they pay off the contract.
Therefore, memorandums of a land contract are recorded in the county to put the world on notice of a transaction. Still, it’s not a deed and that is the actual conveyance instrument. So the due-on-sale clause may not even be invoked. Be advised that if you’re a real estate investor and you represent to a mortgage bank that you intend to use the property as a primary residence and then shortly thereafter you sell it on a land contract for investment purposes, then the lender can call the mortgage for misrepresentation, so be very careful. You should consider speaking with an attorney before you sell an investment property on a land contract.
- Finally, legal remedies. Failure to specifically provide for legal remedies available to a seller in the event of a buyer 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 the seller to collect on monetary deficiencies, such as selling the home for less than what was owed by the buyer under contract. So if a seller is seeking more damages over and above just the payments that were in arrears, then 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 and it’s a waste of legal efforts. So 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 that are purchasing the property or in the purchase transaction.
Land contracts are legal agreements with far-reaching legal implications and they should be drafted and reviewed by a licensed real estate attorney. I hope you got a lot of information in this very brief period.