I am often asked if there are “standard” terms for a Land Contract. I reply to this question that one of the many benefits of a Land Contract is that each Land Contract is the product of negotiation between a specific seller and a specific buyer. The result of this negotiation is a “custom fit” Land Contract for each transaction–without the inflexible guidelines, red-tape, and delays of traditional bank financing.
That being said, if you’re thinking about selling your home or other real estate on a Land Contract, there are some things you should know that could be beneficial to you in the future…especially if you or your heirs want to sell that Land Contract for cash someday. The way a Land Contract is written can have a lot to do with its value to you in the future.
As a Seller, you naturally would like to receive the highest price, largest down payment, highest interest rate, largest monthly payment, and shortest term that also work for the buyer. The market (supply and demand) is going to be the best gauge, but here are some helpful hints:
The Purchase Price – The purchase price is negotiated between you and the buyer, but there are some objective standards that can be used as the basis for negotiation.
One method is to have three different Realtors do a market analysis on the property. (This is sometimes called a Broker Price Opinion and contains sales prices and data about properties that are comparable to yours to help gauge your properties market value.) An average of these three opinions will usually give you a good idea of what the property may sell for. This service is often free since the Realtors will be competing for the right to list your property. (Be advised, though, that an inexperienced or unethical Realtor may be tempted to overestimate the value of your property in order to “win” the listing.)
A second method is to hire an independent appraiser to do a complete appraisal on your property, which would include (as above) at least three comparables. This method is more expensive, but it is also more authoritative.
The Down Payment – The down payment should be as large as possible. A larger down payment means the Purchaser has more equity and owes less, both of which make the contact more secure and more valuable. You should ask if the down payment is coming from the buyer, the buyer’s parent(s), or another source. If the down payment is coming from a loan that requires monthly payments, this additional obligation may affect the buyer’s ability to make the Land Contract payments in the future. Politely but firmly ask where the money for the down payment is coming from and make your selling decision accordingly.
Finally, avoid “zero down” ($0 down payment) Buyers. Making no down payment is a shrewd way to purchase property but a poor way to sell it. Making down payments over time ($1,000 today, $1,000 in six months, etc.) is another version of the $0 down Buyer. Consider carefully: Do you really want to sell to a Buyer who is unwilling or unable to financially commit to the property?
The Interest Rate — The interest rate on your Land Contract should be negotiated with the buyer. Many Land Contracts are written at interest rates higher than interest rates currently charged on mortgages that come with mandatory closing costs. There are legal maximum interest rates in Michigan and most states. See your attorney for details.
The Monthly Payment – The amount of the monthly payment is negotiated with the buyer. Be careful to avoid a “negative-amortization” or a “non-amortizing” Land Contract. You can check this entering by entering the Land Contract balance (after the down payment is applied), the interest rate and the term of years (5, 10, 15, etc.) into a loan amortization calculator. Land Contracts can be structured as fully amortized, or with a “balloon payment” due in 5 to 10 years. A “balloon payment” means the full amount owed will be due at that time. Be aware that a cautious, careful, or conservative buyer is often a good buyer . This type of buyer may correctly see a balloon payment as a potential time-bomb and may be hesitant to buy your property if you insist upon a balloon payment. Even if you Buyer does not object, don’t set balloon dates that are unrealistic as this may create unnecessary difficulties for both you and the Buyer. Keeping the Buyer’s payment manageable gets the Seller paid off in the desired time. If you need any assistance in structuring the payment plan, please call me at 248-335-6166 or Click to Email Allan Daniels.
Amortization – How long a loan is schedule to run is referred to as the amortization. The amortization depends on the size of the contract, the size of the monthly payment, and the interest rate being charged. (The higher the rate and/or the smaller the monthly payment, the longer the amortization will be.)
For you, the Seller, the shorter the contract the better. To shorten the length of the contract, you can increase the down payment and/or increase the size of the monthly payments. Contracts with 5, 10, 15, and 20-year amortization are common and often have more value than contracts with 30-year amortizations.
Taxes and Insurance – The person responsible for making tax and insurance payments can vary depending upon the terms of the Land Contract. There are 3 common ways to handle taxes and insurance payments:
1. The Buyer pays taxes and insurance and sends paid receipts to the Seller.
2. The Seller pays the taxes and insurance, but then adds the amounts paid back to the balance on the Land Contract.
3. The Buyer makes monthly installment payments approximating one-twelfth of the estimated yearly real estate taxes and yearly insurance premium per month to an “escrow account” held by the Seller, and the Seller pays taxes and insurance out of this escrow account. (Remember, this “escrow” money belongs to the purchaser and should not be commingled with your own money).
Note that Land Contracts written to handle taxes and insurance under Method 2 and Method 3 begin with an estimated monthly amount to cover taxes and insurance. The monthly tax & insurance payment should be adjusted yearly to reflect actual tax and insurance billings. Be sure your Land Contract form includes an appropriate clause.
Underlying Debt – If you currently owe money on your home or other real estate, check the mortgage or Land Contract you are paying on to see if there is a “Due on Sale” clause requiring you to pay off the debt if you sell the property.
The Borrower’s Credit Worthiness – You can request the Buyer’s permission to obtain information that shows the Buyer has an adequate source of income to pay the obligation. Get references, find out where he/she works, annual income, and properly request permission to obtain a credit report showing how promptly current debts are paid.
Questions — If you have any further questions about selling property on a Land Contract, please Click to Email Allan Daniels or call 248-335-6166.