Land Contract Can Bypass Appraisal, Credit Problems

Aaron crowe
Written by
Aaron Crowe
Read Time: 4 minutes

If you're having trouble buying or selling a home due to appraisal issues or other lender problems, you might consider a land contract.

Land contracts tend to be popular during times when home sales are lagging. They were quite common during the 70s and 80s when mortgage interest rates soared into the teens, but largely disappeared during the easy credit days of the last decade.

Lender approval not needed

The advantage of a land contract is that it's an agreement just between the buyer and seller - there's no involvement by a regular mortgage lender, except indirectly (more on that later). This can make it easier to conclude a sale, because only two parties have to be in agreement - you don't need to get a lender's approval or satisfy its demands for such things as an appraisal, down payment or credit check, among others.

What can make a land contract attractive in the current housing market is that these are exactly what's been thwarting a lot of potential sales. Getting an appraisal that supports the agreed-upon sales price has been a particular problem. With a land contract, an appraisal doesn't matter, as long as the buyer and seller agree upon a price.

A word of warning, though. Land contracts can have some significant downsides, for both the buyer and seller, particularly if they're not structured carefully, and the laws governing them vary from state to state. The assistance of an attorney is strongly advised.

Seller-backed financing

A land contract is a form of seller-backed financing. Instead of making mortgage payments to a bank, the buyer makes regular installment payments to the seller directly. The seller keeps the deed to the property until the terms of the sales contract have been fulfilled, then signs it over to the buyer.

Land contracts have traditionally been a way for people with little money for a down payment or weak credit to get their foot in the door of home ownership. They're typically structured with a balloon payment after five or more years, under the assumption that the buyer will be able to refinance into a regular mortgage at that point and the seller will be free of the property.

In the current housing markets, land contracts offer sellers a way to unload a property they've had trouble moving, or simply get a better price than the property would appraise for. In many cases, the goal will be to use the buyer's payments to cover the seller's own payments on the property's underlying mortgage.

Possible downsides of a land contract

Unfortunately, in many cases this is likely to be a violation of the underlying terms of the mortgage, meaning the bank may demand immediate payment in full if it discovers the arrangement. This is one of the reasons that land contracts are typically not registered with the county, and why it's important to consult with an attorney in structuring any land contract agreement.

If you're a buyer, one of the other major risks in a land contract is that if you miss a payment, the property could revert back to the seller, who in many states is then allowed to keep your previous payments as rent - including any down payment you may have made. Another possibility is that the seller may neglect to use your payments to cover the underlying mortgage, assuming there is one, and the bank may foreclose.

Particularly in the current market, there's also the risk that the value of the property may stagnate or decline over the coming years, meaning you won't be able to obtain regular financing when your balloon payment is due, though in that event the seller may be willing to negotiate an extension.

For the seller, the flip side of the falling property value problem is that the buyer may simply choose to stop making payments and give up the home, leaving you with a depreciated property. Another is that the buyer may allow the property to deteriorate or make poor quality "renovations" that reduce its value - leaving you with a degraded property in the event of a default.

If a land contract sounds interesting, but you're put off by the downsides, you might also consider a rent-to-own or lease-to own arrangement, either as a buyer or seller. These are similar to a land contract but with somewhat different rules and may be more to your liking.

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