Land contracts: What they are and how they work

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Not everyone takes the traditional path to homeownership. For some buyers, especially those facing credit challenges, limited financing options, or recovering from a foreclosure or short sale, a land contract can offer a way forward. This guide explains what a land contract is, how it works, and what to watch out for if you’re considering this route.

What is a land contract?

A land contract is a written legal contract, or agreement, used to purchase real estate, such as vacant land, a house, an apartment building, a commercial building, or other real property.

As a type of specialty home financing, a land contract is like a mortgage. However, rather than borrowing money from a lender or bank to buy real estate, the buyer makes payments to the real estate owner, or seller, until the purchase price is paid in full.

Depending on the legal or common real estate terminology in your area, you may see these types of deals referred to as land contracts, installment land contracts, land sale contracts, contracts for deed, memorandums of contract, real estate contracts, or bonds for title.

No matter the name, the structure is generally the same: the buyer takes on the financial responsibility while working toward full ownership.

How is a land contract different from a mortgage?

Unlike traditional financing, land contracts are completely between you and the owner of the house, so each one will likely look a bit different. The seller sets the credit score requirements (if any), down payment, interest rate, monthly payment, and purchase price.

It’s a more flexible option, but that also means there’s less protection built in. As a buyer, you’ll want to review every detail and negotiate carefully to avoid terms that could put you at a disadvantage later.

These agreements often last anywhere from a few years to 20 years or longer, depending on the terms. Shorter contracts are common with owner-financed deals, while longer terms may apply if the agreement falls under federal programs like USDA land contract guidelines. There may also be a balloon payment due at the end, so it’s important to plan upfront so you’re not caught off guard later.

Lenders structure most mortgages so that they can be sold to major investors in the mortgage market, such as Fannie Mae and Freddie Mac. Because of this, mortgages follow a standardized set of formal terms for missed payments and any loan modifications.

How does a land contract work?

A land contract is typically between two parties: the buyer, sometimes referred to as the vendee; and the seller, also known as the vendor. In a land contract, the seller agrees to finance the property for the buyer in exchange for the buyer meeting the terms agreed upon in the land contract.

When the buyer receives ownership rights depends on the type of land contract. With a traditional land contract, the seller keeps the title until the buyer pays off the contract. If it’s a wrap-around land contract, the seller continues to make existing mortgage payments while collecting monthly payments from the buyer; however, the buyer gets the deed right away.

This flexibility can open doors for buyers, but when you buy through a land contract, you’re working directly with the seller; no banks or underwriters, just the two of you and a legally binding agreement.

Traditional land contract vs. wrap-around land contract

Land contracts aren’t one-size-fits-all. Depending on your financial situation and your goals, one structure may offer more flexibility or risk than the other. Let’s compare two ways to structure a land contract.

• Traditional land contract: In this type of land contract, the seller keeps the legal title to the property until the land contract is fully paid off. Meanwhile, the buyer gets equitable title, which enables them to build up equity in the property and can allow them to pay off their land contract by converting it into a regular mortgage, which we’ll discuss later.
• Wrap-around land contract: In a wrap-around land contract, the buyer and seller essentially agree to a seller-financed land contract. However, the seller keeps paying on their existing mortgage, pocketing the difference between their mortgage payment and what they’re paid on a monthly basis by the buyer. Unlike a straight land contract, the buyer in a wrap-around land contract gets the warranty deed to the property immediately, meaning they own the home from the beginning of the contract.

One key difference between the two contracts is that the seller’s lender must agree to a wrap-around land contract. A due-on-sale clause is common in most conventional loans that require borrowers to pay the remaining balance if the property is sold or transferred. If a buyer and seller enter a wrap-around land contract without the lender’s consent, the lender could claim an interest in the property.

Traditional land contracts may be more approachable for buyers who need time to build credit or save for a larger down payment while gradually working towards ownership. A wrap-around contract can make sense for buyers who want or need the deed upfront. Keep in mind that it may carry more risk since the seller is still managing the underlying mortgage.

What does a land contract cover?

A properly executed land contract has several components. Let’s look at a few of the basic items.

Sales price

This covers how much the property is being sold for, or the agreed-upon purchase price in your contract. As you make your monthly payments, you’re chipping away at both the principal and interest outlined in your agreement. Once you pay off this amount of principal, your obligations under the land contract are over. If it’s a straight land contract, you’ll get the legal title and will take possession of the property at the time of payoff.

Down payment amount

Your down payment is due at your closing and expressed as a percentage or a flat amount in your land sale contract. Unlike traditional financing, there’s no universal standard here. Some sellers may accept a modest upfront payment, while others may require more. It all comes down to the terms you negotiate and what both parties agree to from the start.

Interest rate

In a land contract, there’s no fixed rule for what the interest rate must be. Instead, it’s something you and the seller agree on during negotiations. But in some states, land contracts are subject to interest rate caps to protect buyers. For example, Michigan limited private land contract interest rates to 11% under state law.

The land contract defines the interest rate, as well as the terms around whether the rate can ever change. If it can, the contract also explains when and under what conditions the rate might adjust.

Another thing to consider is whether the rate stays fixed or can adjust. The flexibility of land contracts is helpful, but it’s worth reading the fine print and asking the right questions before moving forward.

Payment amounts

The land contract will outline how much you pay, how often, and for how long. Most agreements follow a monthly schedule, but some may differ. Be sure to look closely at the due dates, any late fees, and whether there’s a balloon payment required at the end of the term.

You’ll also want to see if there’s a prepayment penalty. This is a fee some sellers charge if you try to pay off the contract early.

Responsibility of the parties

In addition to the basics, the contract should include clauses stating the responsibilities of the parties to each other – for example, whether the buyer will be agreeing to make the mortgage payment.

For the benefit of both parties, the contract should also have clear language regarding what happens if the buyer falls behind on their payments. Life happens, but the consequences of a mortgage default are serious. If there’s any grace period, the contract should clearly define that window, along with when the seller has the right to reclaim the property.

Title settlement

Title settlement is the final step in the transaction, where the seller transfers ownership of the property to the buyer. It’s the moment everything becomes real: finalized paperwork, distributed funds, and the transfer of the title upon the fulfillment of the terms of the land contract.

If you’re the buyer, you’ll want language that says you get the legal title if you meet all loan terms. If it’s a wrap-around mortgage, it’s a good idea to include in writing that the seller will make payments on the underlying existing mortgage. That way, if the seller doesn’t make the payments and the buyer loses the house because of it, they have the option to take legal action.

You may want a clause that requires the seller to keep track of your payment history. This step will make paying off your land contract with a conversion to a traditional mortgage easier later.

Pros of a land contract

There are pros to a land contract over other types of mortgages. Here’s a closer look at why this financing option might be a better fit.

It’s easier to get financing

Land contract home financing can open doors for buyers who struggle to qualify for a traditional mortgage, especially those trying to buy a house with bad credit or limited financial history. Because the seller sets the terms, this type of agreement may be more flexible than what a bank would offer.

That said, before you commit, it’s worth exploring all your options. There are several mortgage programs designed for buyers with lower credit scores, and one of those might offer better protections or lower costs.

It’s a win-win for sellers

The seller accomplishes the goal of selling the property while still getting a periodic income stream throughout the term of the contract. If the buyer doesn’t make the payments, the seller can take the property back pursuant to the terms of the contract.

Still, this kind of deal requires more than a handshake. Sellers should plan to spend time reviewing offers, negotiating terms, and managing payments over the life of the contract. Most also spend money upfront to hire a real estate attorney who can draft or review the agreement, make sure it complies with local laws, and include protections in case the buyer defaults.

Depending on the complexity and the attorney’s fee structure, this could cost anywhere from a few hundred to thousands of dollars. However, taking the time to get the paperwork right can prevent expensive legal disputes down the road.

It provides more opportunities to purchase

Seller financing through a land contract opens the door for buyers who may not meet traditional loan guidelines but still need more space. A land contract gives you the chance to buy now and refinance later once your balance lowers, your credit improves, or you meet new loan criteria.

Cons of a land contract

There are also cons to consider before jumping into a land contract. Here’s what you should know.

The buyer depends on the seller

As a buyer, you’re placing a ton of trust in the seller. For instance, if it’s a wrap-around land contract with an existing mortgage, the seller continues making payments. If they stop, the buyer can lose the home through no fault of their own. This is why buyers must make sure they have protections in this scenario.

Require written proof that the seller will stay current on their mortgage, and add a clause that gives you legal options if they don’t. You can also work with a title company or attorney to set up an escrow agreement, where payments go through a third party. That way, everyone stays accountable.

Contract vagueness

Make sure the contract spells out the responsibilities of each party in plain language. You’ll want to know exactly what the payment terms are, as well as whether the terms can change and under what circumstances. If anything seems vague or uncertain, consider hiring a real estate attorney to help you negotiate clear terms.

Put in writing that you get legal title to the property no later than when you pay off the principal, as defined by the sale price of the property. To confirm the seller has ownership rights and can legally transfer the property, you may also insist on a title search. Request a title search to reveal any encumbrances or existing liens on the property for unpaid property taxes or other outstanding debt.

Higher interest rates

The seller knows that you’re interested in a land contract because you may not qualify for a standard mortgage. Because the seller is taking on the higher risk, they’ll probably charge you a rate that’s higher than current market interest rates for traditional financing.

Before you agree to the rate, compare it with current market averages so you understand the difference. If the rate feels too high, don’t be afraid to negotiate or walk away.

Homeownership gray area

In a straight land contract, you receive equitable title so that you gain equity as you make payments on the loan from the seller. However, the seller holds legal title until you pay off the property. This could cause issues around who owns the property if you need to handle legal disputes or file insurance claims.

Ownership is further complicated by the fact that many jurisdictions don’t require buyers or sellers to record the land contract with the county. For this reason, it’s difficult to get a sense of how many land contracts exist in the U.S. The census only includes contracts that buyers voluntarily report, so unless a legal proceeding brings the contract into public view, only the buyer and seller may know it exists.

Converting a land contract into a traditional mortgage

Refinancing out of a land contract gives you the chance to lock in a lower interest rate, build equity, and secure full ownership of the property. When you’re ready to transition to a traditional mortgage, the lender may verify the value of the property with an appraisal. You’ll need the following items in addition to standard income, asset, and credit checks:

• A copy of the fully executed land contract: The lender will need to know the balance they’re paying off to determine the loan amount. They’ll also want to make sure any underlying mortgage in a wrap-around contract would be paid off so that the title is clear.
• Payment history: It’s important to provide the lender with as long a payment history on your land contract as you can get your hands on. They’ll use this to verify your qualifications.

The bottom line: Land contracts are another option for home buyers

A land contract offers an alternative path when traditional financing feels out of reach. It can give buyers more flexibility, more time, and a real opportunity to build toward ownership, even if their credit isn’t perfect.

But flexibility doesn’t mean skipping the important details. Before you sign, understand how the contract works, what protections you need, and how you’ll transition out of the agreement when the time comes. Don’t hesitate to get legal help or a second opinion.

If you have questions about which financing options best suit your needs, start a mortgage application today with Rocket Mortgage^®.