The Importance of a Memorandum of Land Contract
I recently prepared a land contract for the seller of an investment home to her current tenant. As part of the process, I drafted a Memorandum of Land Contract (“Memorandum”) for the parties’ endorsement. In the past, my seller had sold several properties on a land contract but had never seen a Memorandum before. She questioned its need and importance. I explained to her the following:
What a Memorandum Is. A Memorandum of Land Contract (“Memorandum”) is a legal document that evidences the relationship between a property owner and the purchaser under a land contract. To be effective, it needs to be filed or recorded in the county property records where the property is located. The Memorandum of Land Contract will specify the name of both the seller and the buyer of the property, the common and legal address of the property and the date on which the agreement was entered. Inserting additional terms into the Memorandum is at the discretion of either party, but one of the reasons to use a Memorandum is to keep details of a transaction private.
What a Memorandum Isn’t. A Memorandum can elaborate on the terms of the purchase, such as the term of the agreement, or the monthly payment, but that really isn’t necessary. The real purpose of the Memorandum serves as notice to the “world” that a subject property is under a seller-financed purchase agreement. There is no law that requires a Memorandum for a land contract to be valid; however, it is highly recommended for both seller and the buyer that one is properly drafted and recorded.
Why a Memorandum Is Important to the Purchaser. Without a Memorandum filed in the county property records, third parties wouldn’t be aware that the buyer’s intended property is already under a purchase agreement. Otherwise, an unscrupulous seller could impair the marketability (the ability to sell free of any encumbrances) of the property by, for instance, taking a mortgage out on the property. Or even worse, the seller could turn around and sell the property to another buyer. Generally, in most states, this ‘second buyer’s” interest is protected against the initial purchaser who failed to file their land contract interest. The only time a lender or prospective purchaser could even know that a property has already been purchased or pledged would be when a title search revealed the recorded Memorandum.
There are other precautions and provisions that one can use when drafting a land contract that would prevent a seller from encumbering a property without notifying the buyer, but none is more effective than the recording of the Memorandum. I have counseled many purchasers buying on a land contract, who have come to me only after they had learned that their seller sold the property out from under them. A filed Memorandum would have stopped this type of seller misconduct.
Why a Memorandum is Important to the Seller. The seller should also record the Memorandum if they ever want their buyer to pay them off by obtaining financing elsewhere. True, land contracts serve as a good investment vehicle that generates income, especially in this low-interest environment. But sellers finance their buyer’s purchase for various reasons, such as when the condition of a home would not pass a bank inspection, or when a purchaser does not qualify for a bank loan. When the economy was soft several years ago, banks were not willing to lend and the need for seller financing using land contracts exploded.
Most lending institutions require that the land contract, as evidenced by the Memorandum, be recorded before the bank will lend. The bank is usually looking for at least 12 months of “seasoning”. A loan is considered “seasoned” when there is a verifiable payment history for a specified length of time. A lender is not likely to lend otherwise. Recorded Memorandums serve to legitimize the existence of a transaction with the essential terms of the underlying contract: start date, parties, property address and amount of the sale.
Conclusion. Comprehensive documents for a property sale under land contract include a Memorandum of Land Contract. Both sellers and buyers should insist that their real estate attorney draft and then record one for everyone’s legal and financial protection.
About David: As a real estate attorney and “former bank insider, ” author David Soble not only ‘talks the talk, but “walks the walk, ” with over 25 years of practical real estate and legal experience gained from his ownership interests in hundreds of mortgages, notes, and income producing properties. David has successfully represented numerous banks, lenders, investors and consumers on both sides of the negotiation table in thousands of transactions.
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