A land contract, also called a contract for deed, has a number of advantages for both buyers and sellers, and can provide an alternative to mortgages for financing a home purchase. Instead of getting a mortgage, a buyer can turn to the person selling the property to finance the purchase.
The buyer would repay the seller in installments according to an agreement. It's usually easier and cheaper in terms of closings costs to get into a land contract versus a mortgage. In many cases, it can help a buyer who may not qualify for a conventional mortgage.
However, land contracts do have some downsides to consider. They don't have as many consumer protections, and the seller retains the rights to the property until the final payment is made.
Learn more about the difference between land contracts and mortgages, and how to determine which may be best for you.
What’s the Difference Between a Land Contract and a Mortgage?
Here are the main differences between a land contract and a mortgage:
|Contract between a seller and a homebuyer||Contract between a lender and a homebuyer|
|No legal right to the property until the contract is fulfilled||Legal right to the property|
|Little or no closing costs||Closing costs|
|Fewer qualification requirements||Stricter qualification requirements|
|Fewer consumer protections for buyer and seller||Stricter consumer protection rules in place|
|Larger pool of potential buyers||Smaller pool of potential buyers|
|Less common||More common|
Parties in the Contract
In a mortgage, the parties are you and the lender. In a land contract, the parties are you and the seller.
Depending on whether the seller is still paying their mortgage, a lender may be involved, with the seller acting as a middleman and pocketing the difference between your monthly payment and their mortgage amount. Called a “wrap-around contract,” this contract involving a lender results in a situation similar to a rental situation. Except under a wrap-around land contract, the buyer is the legal owner of the property.
Your legal rights with land contracts can vary significantly compared to standard mortgages. They typically afford buyers less rights to the property than standard mortgages. Buyers may still have what's called an "equitable title" in the property. That allows them to take physical possession and build equity, but it doesn't give them the full property rights they'd have with a mortgage.
In general, in a land contract, the seller usually retains legal ownership of the property until the contract is paid off.
Consult a real estate attorney when you're considering a land contract so you understand your rights and limitations with a proposed contract.
One of the reasons why land contracts are easier to get into is because you generally don't have to pay lender closing costs. In comparison, closing costs on a mortgage can run between 3% and 5%.
The median sales price on a new home was $374,400 in May 2021. For that price and with a conventional mortgage, you would need to budget up to an additional $18,720 (5%) for closing costs.
Mortgage lenders tend to have very strict underwriting guidelines. And while some are less restrictive, such as with FHA loans, you'll generally need to demonstrate good credit and strong income to qualify.
Land contract sellers, on the other hand, can be as picky or as accepting as they want. The financing terms are up to the individual selling the property with the land contract. So if you have bad credit or a challenging income situation, it may be easier to get into a land contract if the seller is willing to take a chance on you.
Land contracts may be more loosely regulated, but that can have negative consequences as well as benefits. With land contracts, your rights to ownership aren't as protected as if you had a mortgage. There are many rules regarding what lenders can and can't do if you meet your mortgage obligations.
With a land contract deal, you're more at the mercy of the seller. Land contracts can even have predatory lending provisions in them, which is why you should consider hiring a real estate attorney to fully review the terms.
For example, balloon payments (where you owe a large lump sum later in the payoff process) are banned with conventional mortgages because they could cause borrowers financial harm. Land contracts often include balloon payments.
Pool of Potential Buyers
Since land contract deals may be easier to qualify for, the amount of potential buyers for any given home theoretically is higher. Still, not all buyers are willing to sign up for a land contract, especially if they're able to qualify for a mortgage with better rates and better consumer protections.
Not as Common
Land contracts aren't as common as they used to be. If you can’t qualify for a mortgage, you may not be financially ready to buy a home yet. And while mortgage lenders might be willing to lend you enough so you buy a home and become “house poor,” they may still have stricter lending criteria that can protect from you from assuming a loan you can’t repay.
Furthermore, land contracts may not be as easy to find if you're a buyer because they are offered through individuals, not financial institutions. Buyers may have to rely on word-of-mouth referrals or find individual offerings through various sources such as online postings.
Which Is Right for You?
For those who qualify, the traditional mortgage will likely be the better financing option. You would have more rights with your property and more protections against lender abuse. In addition, mortgage rates are near historic lows. So aside from the upfront closing costs, you may find it's cheaper (or at least competitive) to use a mortgage rather than a land contract.
On the flip side, if you're unable to qualify for a mortgage or afford the upfront costs, a land contract may be right for you. However, it's important to exercise caution and consider the terms of the contract carefully. Consider consulting a reputable real estate attorney to vet the contract and help you understand the terms.
If you're not able to qualify for a mortgage, ask yourself if you’re really ready to buy a home? Would waiting a few more years to repair your credit and save up to get a traditional mortgage be better for your finances in the long run?
The Bottom Line
If you can’t qualify for a traditional mortgage, a land contract might be a solution to help you buy a home now.
Rather than signing a contract with the mortgage lender, you would sign a contract with the seller. Because that contract is between you and the seller, you may get more flexible terms. Weigh all the pros and cons, perhaps with guidance from a professional.
Frequently Asked Questions (FAQs)
How does a land contract work?
In a land contract, the home seller acts as the lender instead of a bank. The seller and the buyer agree to terms. Since there are far fewer restrictions and rules governing land contracts, it may be easier to buy a home with a land contract, but you also have fewer consumer protections.
What’s the typical down payment on a land contract?
The average down payment on a land contract was 17% in a 2019 study of six Midwest states. That said, the majority of people (56%) put less than 10% down.
Who pays property taxes with a land contract?
Generally, the buyer is responsible for paying property taxes. However, like with a mortgage, the buyer may pay them indirectly by sending in just one single monthly payment to the seller. The seller may split this payment up into the principal, interest, taxes, and insurance categories, and pay off the taxes for the buyer, similar to how an escrow account works.
Rocket Mortgage. "Seller Financing: The Good, the Bad and the Ugly."
Rocket Mortgage. "Everything You Need To Know About Land Contracts."
Bank of America. "What Are Closing Costs?"
U.S. Census Bureau. "Monthly New Residential Sales, July 2021."
Wisconsin Realtor's Association. "Twelve Things You Forgot About Using Land Contracts."
Joint Center for Housing Studies of Harvard University. "The American Dream or Just an Illusion?"