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Learn On Land Contract

Part 1

Many home sellers are using Land Contracts in this market to sell their homes.  This series of posts should help you make a good decision about whether it’s right for you.

The appeal of this type of sale are multi-faceted. Here is a non-exhaustive list of benefits to you as the seller in a Land Contract scenario:

land contract
land contract

1.  Buyers are less discriminating.  Buyers who want to buy a home on land contract are likely doing so because they cannot get a mortgage for whatever reason.  The most common one being a low credit score or a recent foreclosure or bankruptcy.  These legal actions take most people a few years to recover from, and in the meantime they still need a place to live.  It is possible to evaluate these potential buyers to determine if they will be able to get a mortgage in the near term.  Until then, they’ll be negotiating less aggressively.  You are not taking advantage of them–you are offering them something they can’t get in “open market.”

2.  Sale price can be higher.  Because you are not only presenting your home on the open market, even though you may have your home listed with a Realtor, you do have the right to ask a higher price.  Since you are providing the financing for the buyer, you ought to be compensated for that risk in either a higher price or a higher-than-market Land Contract rate – or both.  Buyers who are looking for a land contract can’t buy just any home on the market.  They are looking for a seller who is willing to sell in this way.

3.  For the buyer, the housing tax credits apply.  This is a huge motivator for them as well as a way for you to collect some down-payment money.  Your selling to them in this way is the only reason they are collecting the tax credit.  The deal can be structured for them to pay a portion of the credit to you as a retroactive down payment.  The tax credit money can also be used by the buyer to clean up old, nagging credit bills.  This increases their credit score and speeds up the time frame for them to be approved for the mortgage that will pay you off.

4.  Housing Tax credits require a three-year minimum stay.  If your buyer buys from you before the housing tax credits go away, then in order to keep the full credit, they must stay put for three years.  You are less likely to see them walk away from the deal in the early years.

5.  The home you currently live in, as yet unsold, is the last remaining detail keeping you from making the buy of the century in today’s housing market.  Since selling your home would likely mean getting no money from the sale anyway (or bringing money to the closing for many reading this in Mid Michigan), a land contract sale could mean that you are finally free to look for a home in this very attractive real-estate market.

What I like about a Land Contract sale is that it puts under-utilized resources (unsold homes) together with real needs (less qualified borrowers) in a free market.  Both sides benefit. The housing market improves as well, and in turn, the entire region improves.  A higher price (on average) is recorded for the home.  Another home is not listed for sale in the open market where there is already too much inventory.  A buyer that would not otherwise qualify for a home purchase can now buy one.  When it works, everyone wins.  Anyone seeking to sell their home in today’s market ought to at least consider this option.

Part 2

The sellers who use a Land Contract most effectively approach the process with a profit motive and a service purpose.  Doing this in the right way and for the right reasons will allow you to make money from the sale of your home, but also help another family in the process.  Keep these both in view and you will likely do well.  Again, this list is meant to be helpful. It would be advisable for you to consult an attorney as well.

Here are some helpful tips to remember:

1.  Keep a good rapport with the buyer – This is may be the best advice I can give.  Remember, you are helping a family that might not have the credit standing to get into a traditional home loan. Help them out.  Stay in good communication with them.  Help them where, when and how you can.  This deal doesn’t work for you if it doesn’t work for them.  In the event that your buyer needs to walk away from the deal, make sure they know that you were rooting for them all the way!  Why?  Not to mention the fact that you really do care about these folks, you also want to smoothly transition from them in your old home to your next tenant, your next buyer, or to a quick list and sale with a Realtor.  The better your relationship with your buyers, the easier and less expensive that transition will be.  My brother and I have always said: you pick your partners (and your land contract buyers) for how they will act in tough times as much as in good.  Stay close to them.  Help them.

landed property
landed property

2.  Know your rights.  Do the research.  Even talk to an Attorney.  If you had to foreclose on this buyer (take possession of the property back from the buyer legally) do you know what your first step would be, and can you see it through financially?  No one wants to get an emergency education. It’s always a nicer experience to educate oneself in advance rather than under the gun.  I’ve found that knowing how the system works for Land Contract sellers made me more willing to participate.  It’s not tremendously ugly – it’s just something you want to know ahead of time.  The link below is to the Michigan Bar Association white paper on Land Contracts.  It explains “forfeiture” which is a far easier and less expensive way to take back a property.

Also, make sure you know of an attorney ahead of time who can read through your contracts and make sure you are setting this up correctly.  A little money invested up front is valuable insurance in the event you need to pursue your rights under the law.

3.  Keep cash reserves from the buyer’s down payment.  You should have 6 months of your house payments in a side fund if you are planning to sell your home on land contract.  Remember, you could end up with the home back in need of sprucing up.  Make sure you keep a healthy emergency fund.  12 months would not be too much, 6 months is a good minimum amount. Then let the payment differential accumulate for a while.

4.  View this as a lease until it’s done.  Even though this is a recorded sale, you really do not have your home fully sold until you have signed over the deed and collected all of the money (and paid off your mortgage if you have one).  The best mindset to have until that happens is that you are still a landlord.  It’s great when these deals come to completion, but if yours doesn’t, don’t get all emotional about it.  This is just business.  You keep their down payment and deposits, get the necessary forfeiture paperwork signed and move on.  You will likely come out even or ahead if you set it up right at the beginning.

5.  Keep the home insurance with YOUR agent as the seller and maintain the right to pay taxes and insurance on behalf of the buyer.  The buyer pays you each month and then you keep that money for the annual payments to the taxing authority and home-insurance agent.  You do not want to leave tax payments and insurance up to the seller: if they went unpaid, your interest in the property would be compromised.

6.  Encourage the buyer to stay on track to clean up credit or to close whatever the gap is to their mortgage approval.  I suggest giving a reduction in the payoff in the end if the buyer gets the contract paid off or refinanced early.  If the land contract term is 3 years, then give them $1000 off if they pay you off in two.  Make it profitable for the buyer to succeed.

7.  Don’t make the Land Contract terms too attractive.  I usually suggest an interest rate over 7 or 8%.  The mortgage rates in two years will be what your buyer has to take to do the refinance.  We want the payment on the new mortgage to be at or below the payment they are making to you, and for two reasons:  first, because you are taking risk that should afford you a greater than market payment; and second, we want the buyer motivated to refinance.

8.  This one may go with out saying, but make sure that your buyer always owes more to YOU than YOU owe to your lender.  That way, when the buyer pays you off with a mortgage, you don’t have to put money down to pay off your loan.  This could especially be an issue if you have an interest-only mortgage and your buyer is paying down the loan.  Never be caught owing more than is owed to you without being prepared for it (e.g. cash of an equal amount in a side fund somewhere).

9.  Make sure you record the land contract and transfer the property to the new owner. This is a full sale and the lower property taxes as well as any home buyer credits are predicated on whether or not this was a real sale.  Make this real.  Unrecorded land contracts are not real sales and will not allow for any of the benefits of real ownership.

Part 3 – Horror Stories

The fact is that some sellers who have used land contracts have had horrible experiences, and you need to be prepared that some negative things could happen.

What is the worst?  Since you are going to stay in control, keeping the home insurance and taxes paid, you are not in jeopardy of losing the home to a fire or of having the property tax authority taking over your home because of an unpaid bill.  That would be really bad.  YOUR buyers have the ability to pay you slowly, sometimes nothing for a while.  But you will keep your payments up; therefore, your interests in the home are protected.

The most realistic and likely negative thing that could happen goes something like this:  You meet a nice family, down on their luck and in need of help.  You look at their credit and hear their story – although they lost a home to foreclosure 8 months ago, their story of a job loss checks out on the tax returns, and his new paycheck stub says that they can again afford to make a payment. You negotiate a deal.  So far so good.  You close on the land contract and await your first payment, which you expect to receive the first of the following month.

It arrives with coffee stains on it and slightly torn on the 14th.  You breathe a sigh of relief and pray that this is not a trend.  Your prayers are answered, but not in the way you imagined.  Next month you get no payment.  After talking with the nice man, you are convinced that he will pay you something soon.  Then half a payment comes.  Then nothing for a while.  Then more time, and nothing.  Then a payment.

Then, you get nothing for a few months, and they do not return calls.  You get out the Michigan Bar Association white paper you read six months ago and decide to get going on the process.

Three months later, the buyer is forced to leave the house.  You feel badly for them, but you remember that your profit motive is not wrong and you also remember that you offered help along the way more than once.  Your purpose was to serve.  It just didn’t work out.

The next morning, you muster the courage to walk into the house for the first time since handing over the keys and as you open the door . . . .

. . . I’ll let you write your own nightmare here.  In fact, I would have to make one up myself, because other than a few missing appliances and some ruined carpet and paint, I have not personally experienced or heard any actual “horror” stories first hand.  I’m 38 though, and someone older and wiser might recall stories (legends) from the 80s – the last era where Land Contracts gained a ton of market share.

We need to be aware of risks and we can do A LOT to avoid them.  We cannot control other people, however.

Understanding that everyone is motivated first by their own best interest (you included) it is possible to put a deal together where the above is really not all that likely.

Most of the time, even if the buyer walks away from the home, if you have kept a good rapport with them, they do it quietly.  If you collected a few thousand dollars up front for a down payment and you made some money along the way in their payment to you, then you will have enough money to go into the home and get it ready for lease or list again.

It’s not personal, it’s business.

Part 4 – The Due on Sale Clause: a Black Swan?

Black Swans are a fictional bird that everyone talks about but no one ever sees.  Unlike Black Swans, Due-on-Sale Clauses exist and have been exercised by banks in the past.  It is, however, extremely rare – thus I write this post.

A due-on-sale clause is a paragraph written into a mortgage giving the lending bank the right to accelerate the payoff (foreclose) on a home if the mortgage holder (homeowner) sells the home.  Since a land contract is a sale – a transfer of ownership that will hold up in court – the bank would have the right to “call” the loan if the mortgage holder sold in this way.  If you have a mortgage, this paragraph is likely in it.  This is the plain truth.

First, that is not the same as saying it’s illegal for you to sell your home using a land contract.  You are allowed to do it under the law. But it’s wise to gain the permission of your current mortgage lender if you have one before selling your home on a land contract.  You can ask for something in writing or for an opinion by calling the customer-service line.  You will likely be told that they will not put it in writing but that so long as you make your payments on time, the banks current practice is to leave the deal alone and let you pay.

This makes sense.  Banks have enough problems on deals where homeowners are not paying at all, why make trouble on a deal that is performing according to contract, where payments are collected on time?

So, it’s not illegal. And though exercising the due-on-sale clause is the bank’s right, it makes logical sense that they would leave you alone. So why not just go ahead with the land contract?

Well, you do need to be aware of one situation where you might be in hot water.  Remember, everyone (even if that “one” is a group of people called a bank) is self interested – just like you are.  Let me set this up:

You are paying on your mortgage ‘on time’ and have never missed a payment.  Your interest rate is 5.5% on a fixed rate loan.  You sold your home to a buyer using a land contract for $150,000 in a market where you might have sold the home for $135,000 on a good day.  Your buyer is on time every month with automatic draft payments from his checking account to yours.  Everything is going just as planned – you are a few years away from having made a good profit and a great decision.

Fast forward three years.  The average market interest rate is now 9%?  I don’t think this will happen, but it could.  Homes are selling for more money now, your home is worth far more than you owe on it now – it would sell for $160,000 today and you owe $130,000.

If you are the bank, what are you thinking?

Bank:  I currently have a mortgage to this person who is contracted to pay me 5.5%.  If I had that $130,000 back, I could relend it in the open market at 9%.  There is cost in taking over a home by exercising a due-on-sale clause, but it might be worth it.

At the outset, it is not likely that home values will rise a lot if rates are also rising.  So those two things would not likely be true at the same time.  In long-term situations though, it is possible and it could happen.  So, I’m writing about it.

What’s the solution?

Your land contract should include a clause that allows you to cancel the contract with your buyer if your lender accelerates for this reason.  Make it fair, give them their down payment back (or part of it ), but make sure you can cancel the land contract if the bank calls your loan.  Once the home is sold back, the bank will not be able to take over.  They will give you time to do this.

Most of the time, your buyer will have paid you off long ago.  If not, then you can still work with the buyer in a lease-to-own situation for the last while before they get a mortgage and finish the transaction with you.

So, even though a due-on-sale clause is real and something you should be aware of, don’t be afraid of them.  Chances are, like Black Swans, you’ll never see one.

Part 5 – For Buyers This Time

Buying on Land Contract?

Because the $8000 first-time homebuyer tax credit is available to you, and because you may have damaged credit, you may be considering buying a home using a Land Contract.  The following is meant to be helpful but is not an exhaustive list of things to consider when buying a home using a Land Contract.  It is always important to get legal advice from an attorney.

That said, read these paragraphs as a good start to getting your mind around how the Land Contract works:

1. The seller is your lender.  The reason you did not have to submit a pint of your blood and promise your first born to the service of the government is because the entire process of “approving” you for the Land Contract is in the hands of the seller.  The seller is motivated to sell the house and collect payments from you.  If you say that you can make the payments, the seller does not have a lot to go on other than your word.

2. Always pay on time and pay in a way that can be proven.  Use a check that clears through your bank.  Ask the seller if you can directly deposit your payment in their bank account so that your on-time payment doesn’t spend a week on the sellers desk before they get around to depositing it.  When you apply for a refinance mortgage in a few years, you will need to prove that you have made your payments on time.  The lender will not likely accept a letter from your seller stating that your payments were timely.

3. Understand up front exactly what you will need to prove in order to get approval for a mortgage.  Know your credit score and how to improve it.  Know what your income documentation will need to be, and be sure you can submit it.  Know what amount of cash (if any) will be required at the time of refinancing the Land Contract into a mortgage.  Know these things up front and then work to accomplish them.  Consider asking your seller for a discount if you get approved and pay them off early.

4. Know up front what the loan terms will be when you finally refinance into a mortgage.  You need to know that you will be able to afford not only the Land Contract payment but also the payment on a mortgage – likely an FHA mortgage when that time comes.  Contact a mortgage broker ahead of time to make sure you know what your payments will be.

5. While you are paying on your land contract, eliminate all of your other debt.  Going into a Land Contract refinance with credit cards and car loans on top of student loans if they exist is not the strongest position to be in.  You will increase your chances and ability to “perform” or pay off the Land Contract if you have no other debt.  Get serious this time, make a plan and pay off your debt.  I recommend Dave Ramsey’s Debt Snowball method.

6. Keep open communication with the seller.  You are in this together until you pay them off.  Get to know them a little bit.  Stay in close communication.  If you ever have trouble paying on time, call first.  They would love to know about it ahead of time so they can plan for a delayed payment.  Don’t over do it, but ask for help if you need it.  The seller of the home you purchased wants this to work out.  Work together.

7.  Consider, if you are in need of land contract financing, writing letters to sellers in this market.  Drive around the neighborhood you would like to live in.  Write down the addresses of five or ten homes you would be interested in seeing.  Write a letter to the current owner and ask them if they would consider selling the home to you for list price using a land contract.  This may not turn up anything, but there are more than a few frustrated sellers out there, and you might just get one on the right day.  You are solving their problem and they are solving yours.  It’s the free market at its best.

8. You have a right to make sure that the seller is making on-time payments to the lender, taxing authority, and insurance agency.  The last thing you want, and likely your biggest risk in buying this home in this way, is for the seller to default on HIS mortgage or tax payments.  If he gets too far behind, then you could lose your home to HIS bank.  A simple understanding ahead of time that the seller needs to prove that these things are paid on time will save any heartache later.

9. Know your rights.  If you have a hard time making the payments, and your seller is unwilling to work with you, be sure you know what to expect if the seller takes legal action.  Make sure your Land Contract has a forfeiture clause in it.  This clause makes it easy for you to get out of the deal if you need to, and it’s easier for you to cure past-due payments should that ever happen.

The Life of a Landlord: Is it Financially Right for You?

You’ve been searching for the perfect investment, and one day you see it. The perfect little starter home a couple of streets down is going into foreclosure, and it’s almost half the price of the value of other homes in the area.

“Buy me! Rent me out!” it seems to scream every time you pass by it. Although you’ve never been a landlord before, you have been a renter, and you’re pretty sure you have a good idea of the things not to do as a landlord.

You find yourself slowing down every time you pass the property. Sure, the front hedges are a bit overgrown and the porch needs repairing, but it really wouldn’t take too much effort to transform that little house into a place that any renter would love to claim as home. You’re getting more excited by the minute – until you read this article.

Think Before You Leap

That’s right; no matter how enticing it may seem to buy up cheap property and rent it out, it’s important you think through all the ramifications carefully. Yes, you may know how important it is to be an easygoing landlord when things get tough, but what about when your mortgage is due and you’re depending on that rental check to help cover Junior’s football fees?

Are you the type who can control your frustration when your renter is never home and never answers your calls? Are you prepared to deal with hostile renters who are facing eviction?

Are You a People Person?

Being a landlord covers a lot more territory than just finances. It’s a people business; if you aren’t great with people, if you have a quick temper, or if you aren’t a very adept judge of character, you might find that being a landlord is much more trouble than it’s worth. Do you have the insight to tell whether a person will be trustworthy, timely, and truthful?

The most important thing you can do as a landlord is to learn to screen your renters effectively with services offered from places like Rentec Direct.

You have the responsibility to check whether your renter is a sex offender or an ex-con. Sure, they may need a place to live; still, consider the needs of the other residents in the neighborhood. Not only is screening your renters the ethical thing to do as a good neighbor; it just makes sense that you’ll want to know the background of the person to whom you’re entrusting your valuable investment.

The last thing you need is to have a renter who doesn’t respect you or who thinks you’re the bad guy; unfortunately, that’s exactly how many renters view their landlords.

Are You a Handyman, or Do You Hate Maintenance?

Another important consideration is maintenance. Sure, you might be able to fix up that rundown property in short order – although most repairs are much more involved once you get in the middle of them.

Even if you do get the place spotless, you might be surprised how quickly a careless renter could allow the house to deteriorate. How will you handle it if the renter refuses to cut the lawn or trim the weeds around the house? Are you prepared to add the lawn care of another property to your weekly list of chores?

Even the Best Renters Require Attention

Even if your renters are perfect, you’ll still get that middle of the night call crying, “Help! The toilet’s overflowing!” When the pipes freeze, will you be ready and willing to trudge up the icy path and fix it or call a plumber to handle it?

You might even get to the point that, in order to avoid any maintenance hassles, you work out a deal with the renter to provide cheaper rent if they’ll handle such problems themselves. If it comes to that, will the investment even be worth it?

Like any investment, acquiring rental property does have some intriguing prospects. Still, until you’ve thought about all the downsides carefully, you probably better just drive on by unless you’re sure it’s really worth it. After all, who wants to pay to enter a nightmare?

4 Things To Consider When Purchasing Undeveloped Land

Buying undeveloped land is often a good investment. Purchasing a vacant lot allows you to create the home of your dreams or put a new house on speculation and sell it someone else at a profit. Before you buy, there are several factors you may wish to take into account.

Available Services

Any vacant lot should be carefully examined to determine if the lot has the necessary infrastructure in place first. Infrastructure includes access to clean water, plumbing lines, electrical power, sewage services, and other basic services. The lot may have such basic structures in place already. If not, contact local area power authorities to find out about potential costs.

For example, if you live in Alberta, Canada, get in touch with Alberta Water Services for an estimate of how much you can expect to pay for water each month. If you have a business, you’ll be more interested in Calgary commercial plumbing.

Proximity to Houses and Other Structures

Look closely at the vacant lot. Examine the lot plans on a map. Note how closely any properties are nearby. If possible, get out to the lot yourself. See where the nearest houses are to it.

Run a thorough check of any other structures near the properly such as railroad tracks and power lines. You don’t want to get stuck with a property that is next to a potential health or noise hazard.

Unusual Features

The property should also be examined closely for any features that aren’t readily apparent by looking at it on a map. Take close note of the slope of the lot. A lot with a steep slope can be far harder to develop. Only a fraction of the land may be appropriate for house placement.

The rest may be in danger of flooding as a result of the slop. The lot’s vegetation should also be examined. Sometimes a lot may have dangerous and invasive vegetation that may require a professional to remove.

Zoning Laws

Zoning laws are laws dictating how the property can be used. Some places have stiffer zoning laws than other places. A town may permit houses to be developed only on a lot of a certain size.

Find out if the property is located in a zone where commercial development is permitted. Some towns limit commercial development to certain areas. Make sure the lot has the right zoning for the development you envision.

Careful investigation of any property is highly important. Take the time you need to make sure you’re making the right decision before you buy.

Warren Paine

Warren is the senior mortgage loan officer who has worked in mortgages and loan industry since 1995. He study in Harvard and major in Finance with a Bsc. Honor Degree. He possesses a Paralegal Certificate as well.

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