I’d never heard of a land contract until I began practicing law in Ellicottville. Now, I am no stranger to these unique “rent-to-own” agreements. A land contract is essentially a short-term, seller-financed purchase of real property. Buyer takes possession of the property and makes payments toward the purchase price, and seller retains legal title until the full purchase price is paid.
For the most part, the financing is similar to a traditional mortgage, where buyer makes regular payments, including interest on the length of the loan.
Unlike a mortgage, a land contract typically requires either a significant deposit (one-third to one-half the purchase price) up front or a large balloon payment at the end of the loan.
Additionally, buyer’s regular payments are usually in excess of the fair market rental value, the difference going toward the purchase price until the property is paid for. Once buyer completes payment on the loan, title is transferred the way it would be at a traditional real estate closing, with a deed transfer and recording.
Land contracts are useful financing tools where traditional lending is not easily accessible — interest rates are high, loan term is too long, or buyer lacks proper credit. Such agreements are particularly beneficial where the market is not favorable to seller. If the property is not owner occupied, seller often finds relief in having a tenant-buyer living on the property instead of letting it sit vacant.
Land contracts are also favored as a means of family financing where a son or daughter benefits from a lower interest rate and parents collect the interest (instead of the bank). Aging parents may prefer regular payments as a source of income instead of a lump sum.
Although title does not legally transfer until the purchase price is paid in full, New York courts have held that a buyer’s significant financial contribution toward the purchase price under a land contract warrants equitable title to the property. Thus, if a buyer has placed a large deposit on the property or has made several payments that contribute to the purchase price (in excess of fair market rent), she may be considered the legal owner.
This shift in equity can cause concern for both buyer and seller. Where seller owes more on his mortgage than the property is worth, he may try to help cover his payments by entering into a land contract. However, as buyer accumulates equity in the property, buyer is increasingly vulnerable to a mortgage foreclosure, or other judgments, against seller’s title to the property. A wise buyer will require an updated title search of the property before entering into a land contract.
On the other hand, a buyer who is unable to obtain a traditional mortgage may pose a credit risk. If buyer lacks good credit and is not able to put down a significant deposit, seller is justified to wonder if buyer is capable of making future payments — not as a judgment call, but as a matter of financial protection.
This is the case that I see most often — seller is anxious to sell, and buyer is anxious to own his own home. Although both parties are well intentioned, the reality is that buyer lacks credit and cash flow, and seller doesn’t insist on a large deposit. If buyer ends up defaulting on his payments, it is unlikely that a court will deem him to have equitable title; thus, seller’s remedy is to file a summary proceeding for eviction under New York’s landlord tenant laws. Where a buyer falls behind on his payments once he has made a significant contribution toward the purchase price, and a court deems him to have equitable title, then seller must foreclose instead of evict — a more lengthy and expensive process.
It is my experience that land contracts are particularly risky for sellers, but both parties are advised to consider the legal consequences of such a transaction very carefully.