Wednesday, February 14, 2007

Residential Land Contracts 101

In Michigan, sellers of residential property are more interested than ever in finding ways of making their property attractive to prospective buyers. Many sellers are offering leases as an option. Another alternative is to offer a sale by land contract. As an attorney who handles real estate transactions, from time to time I am asked by clients or prospective clients to review the fundamentals of a land contract. That prompted me to post the following primer.

What is a land contract? A land contract is both a method of financing and an agreement for the sale of an interest in real property. Payments are usually made in installments, and the interest rate cannot exceed 11% unless it qualifies for an exemption. Keep in mind, though, that the land contract itself does not convey legal title to the buyer (legal title is transferred by use of a deed). There are various reasons a buyer and seller may choose to enter into a land contract.

Why would a seller want to use a land contract? One reason is that, unlike a traditional sale whereby legal title is transferred at closing to the buyer and the mortgage holder retains a security interest, when a sale of real estate is conducted by way of land contract the seller retains legal title to the property until the conclusion of the land contract, and thus the seller retains the right to use the property as collateral during the course of the land contract (although this right may be barred by the language of the land contract). Another potential advantage for the seller relates to the seller’s remedies in the event that the buyer defaults. Should the buyer default, the seller has the remedy of “forfeiture”, by which the seller can recover possession of the property, retain all the payments the buyer has made to date under the contract, and the seller can avoid the lengthy process of a foreclosure sale.

Why would a buyer want to use a land contract? The most common reason for a buyer to agree to purchase property by land contract is because the buyer, as a result of their credit history or inability to make the required down payment, cannot obtain a traditional mortgage.

Beware of the “standard” land contract. There are many optional provisions for a land contract, including sections relating to prepayment penalties, rights to encumber, duty to place a deed in escrow, disposition of insurance proceeds, payment of taxes and insurance, rights to assign and remedies in event of default. Also, if you have an estate plan, be sure that the way in which you buy or sell property is consistent with that plan, particularly if your plan involves use of one or more trust agreements. Before entering into a land contract, or any other significant real estate contract, be sure to consult with an attorney who can make sure that your rights are fully protected.

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