The changing real estate market has called for a large flux in the structuring of real estate sales, not only for companies looking to flip a quick profit but also for homeowners struggling to stay afloat in their homes. Current market prices have appealed to those looking to take advantage of low price points by purchasing a second home and getting out of their current one.
With the market full of eager buyers unable to finance through conventional mortgage means, land contracts are being used as realistic purchase options in a wide variety of situations, offering a way out of mortgage payments to the homeowner and a way into home ownership for buyers with less than ideal credit. While these situations seem like a win-win situation to a homeowner looking to cover their monthly payments or a home buyer unable to purchase through conventional financing, a number of concerns should be addressed prior to entering such an arrangement. This article focuses on some of the most common issues that arise in land contract situations, especially where the parties do not retain legal counsel to assist them in drafting and implementing the agreement.
With most homeowners having little to no equity in their home, it seems an easy fix to sell for at least the amount owed on the mortgages,thus avoiding a short sale. The problem with such a strategy is that it ignores the appraised value of the home. Most buyers fail to requestan appraisal come land contract execution time either due to lack of relationship with a real estate professional or because they do not have available funds to pay for one. With most balloon terms ranging from one- to ten-years, buyers run the risk of owing more on the land contract than the home is worth. When the buyer attempts to traditionally finance at the balloon date, they often need cash to pay for the difference between the land contract balance and the amount thebank is willing to finance. In some cases, this amountmay exceed $50,000. Without available cash to make up the difference, the seller may be able to declare a default of the land contract and regain possession of the property, even if the buyer has made allof their payments on time.
Many times sellers contact me completely oblivious to the time it takes to get their home back following a default. They oftentimes think that if the buyer misses a payment today, they can kick them out of the house tomorrow. This is simply not the case. Though land contract language typically includes immediate take back provisions, Michigan law requires all land contract sellers to use the court system to evict the buyer, even in the event of non-payment. While Michigan statutes call for a shortened period of time for doing so, the court system does not always work so quickly. The reality is that as a seller, you may go three to four months before the buyer is actually forced to leave the property. Because most sellers fail to set aside reserve funds to pay the mortgage following a buyer default, they may find themselves unable to make the payments, possibly forcing foreclosure issues, all while the buyer stays in the property expense free.
While most sellers are eager to get rid of a property they can’t afford, there are a number of risks in selling a home without receiving the proper mortgage approvals. The majority of mortgage documents specify a default in the event a property is sold without the mortgagor’s express written permission. For purposes of defining the default, land contracts typically qualify, with mortgage companies considering such transfers of property sales. Typical mortgages include a due on sale clause, allowing the bank to call in the entire loan in the event a land contract is signed. Many sellers ignore this facet of the transaction, and while the bank may simply ignore the transfer, with many institutions tightening lending standards and calling in notes, it is a risky move to enter into such an arrangement without addressing the issue. A land contract without the proper approval could quickly turn into a foreclosure.
Typical land contract transactions require the buyer to pay all property taxes and obtain insurance for protection of the home and land. The payment of such expenses is typically the responsibility of the property owner, which the buyer steps in the shoes of during the term of the land contract. Many sellers allow the buyer to make these payments directly to the municipality and insurance company to whom the expenses are due, failing to ever confirm that such payments have been timely submitted and that proper insurance coverage has been secured. These failures can lead to a number of stressful situations in which the property may go into tax foreclosure for the buyer’s failure to timely pay taxes or in the event an uninsured loss occurs to the property due to the buyer’s failure to secure or maintain insurance. Such issues can be avoided by including a number of provisions in the agreement to protect sellers from such risks.
Situations not uncommon in the current market are those where the land contract buyer has made all payments, complied with all requirements of the agreement, and paid all property taxes and insurance amounts when suddenly, they have a foreclosure notice on the door. Often the seller has pocketed the buyer’s monthly payments instead of applying them to the mortgage, leaving the home in foreclosure. Such is also the case where the underlying mortgage has an adjustable rate, leaving the seller suddenly unable to keep up with higher payments in the event the land contract payments are less than the monthly principal and interest due on the mortgage. Without protection written into the agreement and proof of payments, there is no guarantee that a buyer’s payment will be applied to the mortgage. This can leave the buyer having complied with every single provision of the agreement and left without the property, as the bank’s first position lien trumps a buyer’s possessory interest. Buyers and sellers alike should address a number of other items with an attorney, including, among other things:
Even with all of their potential pitfalls, land contracts can be very beneficial arrangements – saving families from short sales/foreclosures or simply allowing them to move into a better house for less money, all while having their payments covered by a willing and able buyer. It is important, however, to first understand the benefits and risks of entering into such an arrangement. Before entering into a land contract, buyers and sellers should both be completely aware of all risks including the time necessary to regain possession of the property in the event of a breach. It is important to meet with an attorney skilled in real estate law to review such items and ensure that the necessary protective provisions are included in the agreement. Failing to do so could put a large investment at too high of a risk for a seller or a buyer in any land contract situation.
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