What Is the Interest Rate on a Land Contract?

by / Tuesday, 23 October 2012 / Published in Blog

The interest rate on a land contract is negotiable between buyer and seller, and it often offers advantages to both. The concept of a land contract is very similar to that of purchasing a home, in which the current owner agrees to carry the mortgage for the buyer. The fundamental difference between a land contact and mortgage is that it’s a quicker, more efficient and usually a less costly way to purchase property. Partly because of the overall ease of the transaction, it’s usually recommended that the interest rate should be about 1 percent higher than conventional lending institutions. On smaller land contracts (under $15,000), a higher interest rate is usually required. However, some states have laws about how high the interest rate can be, so consult a land professional before the deal is signed. The term is negotiable, depending on the needs of the buyer and seller. Some contracts, however, call for a balloon payment at the end of a specified period, typically around 5 or 10 years.

Definition

• A land contract is a written agreement between someone wanting to sell a property and someone wanting to buy it. That’s the obvious part. Sellers usually prefer a cash sale, tax considerations aside. However, land contracts are usually structured as a quick and less expensive way to sell or buy a property without using bank financing. Basically, the seller holds the mortgage for the buyer, who makes payments to the seller that include insurance costs and interest. Land contracts have seen their popularity ebb and flow with the economy and are very common across the United States, where they go by different names such as trust deeds or contracts for deeds or notes. The major difference is that the buyer basically is borrowing from the seller rather than borrowing from a bank or other mortgage lending institution.

Advantages to the Seller

• Typically, the seller nets a higher sales price for a number of reasons. Some have to do with the costs normally paid out of pocket for a conventional sale through a mortgage that can include all kinds of add-on costs, including appraisals and commission fees. There are possible tax advantages as well. However, a tax specialist should be consulted on how to qualify for a deferred income gain. The seller also receives a monthly income in the form of payments from the buyer. If the seller has an outstanding mortgage on the property, he can negotiate a higher payment from the seller, which cover his mortgage payments with a little extra in his pocket. Also, if a property is considered non-conforming by local zoning codes, it avoids the time, cost and effort of receiving a special exception for the land sale. This makes the deal a much quicker one.

Advantages to the Buyer

• The traditional, painstaking paperwork of buying property through a conventional mortgage issued by a bank or other lending institution isn’t applicable, though a savvy seller will likely want a copy of the buyer’s credit report, at a minimum. The down payment is flexible and negotiable, although it typically runs in the 10 percent to 20 percent range. The length of the land contract term and interest rates are also negotiable. Like conventional buying, the higher the down payment, the more likely the buyer will have lower monthly payments. This is because the down payment money can be invested by the seller in a variety of ways–either to lower his mortgage obligation, if there is one, or invest it to produce other income that can be treated as capital gains for tax purposes and thus pay less tax on the money. Again, a qualified tax expert should be consulted. The closing costs are much lower and there are no lending fees. Lastly, if desired, the transactions can be completed very quickly.

Considerations

• For good reason, it’s usually the buyer’s responsibility to maintain the value of the property until it is fully paid off. This requirement can contain all kinds of conditions, as complicated or simple as the seller and buyer agree upon. This is because if the buyer defaults for whatever reason, possession of the property reverts to the seller. And the seller certainly wouldn’t want to take back a property that is of lesser value than for the price it was sold. Usually, there’s a provision in the contract that the buyer will notify the seller if any changes to the property are to be made before the obligations of the contract have been fulfilled. Once the contract has been paid, the seller obviously must convey the deed to the property and prove that it is free of any liens. The buyer then must record the deed, showing he is the new property owner.

Important Detail

• The land that is to be bought and sold must be surveyed and specified in detail to avoid any disputes either along the way or, most especially, when the terms of the contract have been satisfied. A poorly defined property deed leads to headaches and additional time and costs in the end; the deed may not be able to be satisfactorily transferred if the property records don’t conform to the description of the responsible registering governmental authority. For example, if only part of a large parcel is specified under the terms of the agreement, it will have to be subdivided by the seller and recorded as a separate and distinct land parcel before the deal can be completed. It’s recommended the sub-division occur before the execution of any land sale agreement.


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