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When we think of buying a house, one of the things we think of is lining up mortgage financing. If we have enough cash on hand, maybe we consider buying the house outright and avoiding a mortgage altogether, even though mortgage interest makes for a nice tax deduction.
Regardless of how you come to own your home, you might think the only path is to sign the closing documents and get the title in your name. But there is one type of contract where you don’t get the title right away: a land contract.
A land contract is an agreement between the buyer and seller where the seller will provide the financing for the home purchase. Unlike a traditional mortgage, the seller continues to hold title to the property until the land contract is paid off. Buyers and sellers negotiate a contract that includes things like the down payment, the term of the loan, the interest and how that interest will be paid off.
Let’s dive deeper into why you might get a land contract instead of a mortgage and some of the potential negatives. After that, we’ll go over how to refinance your way out of a land contract if you ever need to. But first, let’s clarify the difference between a land contract and a land loan.
Land Contracts vs. Land Loans
Before we go any further, we want to clear up any confusion over the difference between land contracts and land loans.
A land contracts is a seller who agrees to finance your purchase of their home.
A land loan, by contrast, is financing for land itself. You may choose to put a house, a store, an art gallery or any number of other things on the land. Loans for this type of transaction are typically acquired through financial lenders.
The percentage required for the down payment on the land generally varies based on how you plan to use the property. Down payments of 20% are common, but some lenders may require down payments as high as 50%. Depending on how you plan to use the land, the government may be able to offer lower down payment loan options.
Quicken Loans doesn’t finance land by itself. There must be a home being purchased.
Advantages of Land Contracts
A land contract is helpful if you can’t get traditional mortgage financing. This might happen for a couple of reasons.
If you’re buying a distressed property in order to fix it up, the property might not meet basic conditions to pass an appraisal, usually because of safety restrictions. The mortgage company needs to know the property you’re buying is livable because the loan is secured by the property; if something happens to the home, the mortgage company’s investment is also impacted.
The seller may not want to make the repairs because they may not realize their full investment when the appraisal comes back from the appraiser.
There are mortgages you can get to rehab a property. These allow you to finance both the cost of the purchase and the cost of the renovation necessary to make the house move-in ready. However, many lenders, including Quicken Loans, don’t offer these loan options. And if the seller only accepts cash buyers, the market of potential buyers is limited.
If the buyer is unable to get a mortgage, seller financing through a land contract is an option. The buyers pays off the cost of the property over time at agreed-upon terms.
Mortgages sold on the secondary market are backed through outside sources like Fannie Mae, Freddie Mac or the FHA. These agencies standardize underwriting guidelines so investors can be confident in the bonds they buy based on the loans.
There’s a lot that goes into loan underwriting, but some of the big points that get considered are the buyer’s debt-to-income (DTI) ratio and credit score. While there are good reasons for lenders to rely on this data to help make sound investing decisions, this means some buyers won’t qualify for a mortgage.
Buyers may find it easier to obtain financing on a land contract: The seller may want to pull your credit in order to get a sense of your financial qualifications, but there are no defined credit guidelines to follow for a land contract.
Disadvantages of Land Contracts
While land contracts mean you could have some flexibility in terms of property condition and credit, they also have drawbacks. For starters, you need to be careful with the terms.
If you work out an agreement with the seller that states the payment on the land contract is at a fixed rate for the term of the loan, these terms are fairly straightforward. However, many loans have fixed payments leading up to a large balloon payment at the end of the loan, where a significant portion of the balance is due all at once.
Land contracts also don’t feature some basic protections that mortgages do because the seller holds the title until the contract is paid off. Depending on the way your contract is worded, if you’re late with your payment just one time, the seller could choose to evict you. They do have to conduct a foreclosure process and you may have different rights from state to state, but it’s possible. (With a mortgage, this isn’t the case most of the time because your name is on the title.) If the seller dies or doesn’t pay the property taxes or make timely payments on any existing mortgages, there’s also the possibility that you lose the house because the house isn’t really yours until your name is on the title. This is the case with traditional land contracts, but wraparound mortgages work differently because you get the legal title right away.
Land contracts may have a higher interest rate than mortgages because the seller is taking on more risk, particularly if you can’t otherwise qualify for a mortgage. Let’s say you’ve got a land contract and you now want to get out of it and into a mortgage. What can you do? You can refinance it.
Refinance Your Land Contract
If you decide it’s time to refinance your land contract into a mortgage, there are a few points to be aware of.
When you refinance a land contract, the initial contract you have with the seller gets paid off. Since you’re paying off the full balance of the contract, there are a couple things you need to consider:
- Ensure the title is clean and that the seller has the legal right to sell the property. Having multiple owners on the title could prevent you from being able to refinance. Using a title company to handle the initial recording of the contract can help make this process smoother.
- Look out for any prepayment penalties you may have for closing the contract early. If you really want out, you may choose to pay these anyway, but it’s something to be aware of.
- Know your credit score. If you had a credit score on the low end and haven’t cleaned it up, it could prevent you from refinancing.
- Land contract payments aren’t reported on your credit, so your lender will require other payment verification through canceled checks or bank statements, etc. It depends on the type of loan you get and whether your land contract was with a bank or an individual, but a good guideline is 24 months of payment history.
If you bought a fixer-upper and have made repairs and improvements, you’ll want to make sure that the home is fixed up enough to pass an inspection before attempting to refinance. This means there can’t be any hazards that would affect the livability of the property. When it comes to appraised value, it works a little differently.
- If you’ve been on your land contract for less than 12 months, the property value (for purposes of the mortgage) is based on the lesser of the purchase price or the appraised value. If the mortgage is an agency loan from Fannie Mae or Freddie Mac, you can add your remodeling costs to the purchase price and add those costs back into the loan if it totals to be less than the appraised value. If you’re considering a conventional loan, maintain a record for future selling or refinancing considerations.
- If you’ve had the land contract for more than 12 months, the home value is the value assigned at appraisal.
Are you considering refinancing out of your land contract? Get started online or give us a call at (800) 785-4788.
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