Land Contract: When Is Selling a House on Contract a Good Option?

In this article:

• What is seller financing?
• What is a land contract?
• Benefits of selling a house on contract
• Drawbacks of selling a house on contract
• How to sell a house on contract with seller financing
• Tips for selling in an owner-financing land contract

Selling a house on contract can be a smart way to create a steady stream of monthly income while also attracting buyers who might not qualify for a traditional mortgage. And when you sell a home on contract, you're allowed to collect interest — much like a lender does on a traditional mortgage. Depending on how much interest you're able to charge, you could get a better rate of return than other types of investments. 

But selling a house on contract can be risky if you don't take the necessary precautions to protect what is probably your largest asset — your home. And selling on contract is typically only an option for people who own their homes outright. Let's start by defining some key terms. 

What is seller financing?

Also known as owner financing, seller financing means the seller is financing the property for the buyer, instead of the buyer taking out a mortgage from a traditional lender. The buyer pays the seller a monthly payment that covers principal, interest, taxes and homeowners insurance. Then, after a set period of time (usually no more than two years), they pay off the loan with a balloon payment and take ownership of the home. 

What is a land contract?

A land contract is the contract that results from a seller financing arrangement. The whole process is often referred to as 'selling a house on contract.' 

The land contract is always a written, legally binding contract signed by both buyer and seller. It outlines how much the buyer will pay each month, including both principal and interest. Sometimes, people will use the terms “selling on contract” and “land contract” interchangeably. 

It's important to note that a land contract is not the same as a rent-to-own arrangement. In rent to own, the eventual buyer pays monthly rent payments, with a small amount of additional money added to their payment that goes toward principal, as part of an option-to-purchase agreement. 

How does a land contract differ from a mortgage?

Although they are both types of home-purchase financing, a land contract differs from a traditional mortgage in a few significant ways. 

There’s no deed transfer: In a seller financing agreement, the seller keeps the deed and the title to the home until the land contract is paid off and contract terms are fulfilled. While the seller maintains the title, the buyer is considered to have 'equitable title,' as they have a partial interest in the home. This prevents the seller from selling to someone else simultaneously. 

The seller can set financing qualifications: Since you, the seller, are acting as the lender, you can set your own benchmarks for who qualifies. That means you could offer buyers a lower credit score requirement, lower down payment or lower interest rate than what a traditional lender would be willing to. 

Contract is usually much shorter: Unlike a traditional mortgage that is paid off in 15 or 30 years, with seller financing, the buyer typically pays off the house much sooner. Most seller financing agreements are for two years. At the end of that two-year period, a balloon payment of the loan balance initiates the transfer of title. Sometimes, the buyer will pay the balloon payment in cash, but more often than not, they obtain a mortgage from a traditional lender to complete the purchase. 

Benefits of selling a house on contract

Seller financing can be appealing because it opens up a new pool of potential buyers and because it gives you more control over how you receive the equity in your home. 

Attract more buyers: Buyers are often interested in seller financing because they are unable to qualify for a traditional mortgage, or at least unable to qualify for an interest rate that will make a home affordable. If your home has been on the market for a while without receiving any strong offers, providing seller financing can make your home attractive to a new set of buyers. 

Produce monthly income: Some sellers prefer to receive monthly payments over time instead of one big check at closing. Receiving your equity a little bit at a time as the buyer makes their monthly payments can help you keep your finances in check and keep you on track toward future goals, without the responsibility of a large lump sum. 

Collect interest: Depending on current mortgage interest rates, you might be able to charge as much as 5% interest, in addition to the principal payments. Depending on the other types of investments you put your money in, you could get a higher return by selling on contract. It's up to you to set the interest rate. Consider setting a higher interest rate for buyers with poor credit or a smaller down payment. 

Close faster: Since a traditional bank isn't involved, the closing process can be faster and simpler — there's no underwriting from a lender and no appraisal. This can also save both parties money at the closing table. 

Get a higher sale price: Because you're helping the buyer essentially 'pre-purchase' their home, you can negotiate a higher purchase price to account for the home's value increasing over the course of the time they're paying off the loan. 

Spread out capital gains tax payments: Because you are receiving your equity a little at a time, you can spread your tax liability over multiple years. Everyone’s financial situation is different, so check with your tax professional on your capital gains tax liability, especially as it relates to capital gains tax exclusions for the sale of a primary home. 

Drawbacks of selling a house on contract

While there are definitely benefits to selling a house on contract, you should also be aware of some downsides.

Assuming risk: Be diligent in vetting buyers to make sure you find someone who can complete all payments while maintaining the home. 

Attracting unqualified buyers: If you market your home with a seller financing option, you might attract buyers who can't qualify for conventional lender financing for good reason — like poor credit, insufficient income, previous mortgage default or poor payment history. Unqualified buyers can waste your time and get your hopes up unnecessarily. 

Inability to access equity: If you find yourself needing a large amount of cash sometime during the seller financing contract, you can’t access it until the buyer has finished paying off their loan. 

How to sell a house on contract

Before you start seriously contemplating a land contract, check with your lender. If you’re still paying off your mortgage, it’s unlikely that your lender will approve a seller financing arrangement. So the best candidates for owner financing are sellers who have already paid off their mortgage and own the house free and clear. 

1. Find a buyer

If you're pursuing seller financing because you're having a hard time selling, make it clear in your listing description and in other marketing materials that you're offering seller financing. If you’re working with an agent, ask if they have experience with seller financing deals. Their expertise can be a big help. 

2. Set a purchase price

Identify an appropriate purchase price using recent comparables from your neighborhood. Remember, you may want to set the price a bit higher than the current fair market value to account for how much the home's value will increase between the time you start the seller financing agreement and when the buyer pays off their loan and officially becomes the owner.

3. Write up a land contract

Since this transaction involves what's probably your largest asset, it's considered best practice to hire a real estate attorney to guide you through the process. Be sure that your land contract includes the following pieces of information:

• Sale price
• Down payment amount
• Monthly payments, with interest
• Buyer responsibility for maintenance and upkeep
• Balloon payment amount and payoff date
• Title transfer date
• Other stipulations, like late payment fees or title insurance

4. Have it notarized

Have both parties sign and date the contract, then have it notarized by a notary public to make it fully valid. 

5. Set up a disbursement account

A disbursement account is run by a third party responsible for coordinating payments between buyer and seller, as well as paying things like property tax bills and homeowners insurance premiums. This allows you to keep your address confidential to maintain a more professional business relationship, much like a traditional mortgage lender would do.

Tips for sellers in an owner-financing land contract

Because you'll be assuming the role of lender, you'll want to fully vet the buyer before offering a seller financing contract. Here are a few things you must do to protect your financial interests. 

Check the buyer's credit score

Act like a lender and pre-approve your buyer before you sign their contract. This starts by checking their credit history. Watch for red flags like a history of missed payments or a mortgage default. 

Note that some people might pursue seller financing simply because their credit score is low. If they have a legitimate reason for having a lower-than-desired credit score, like a divorce, a medical issue or a financial issue that's since been resolved, you might still move forward if everything else in their profile checks out. 

Verify the buyer's employment or income

Like a lender, you'll want to be sure that the buyer has enough money to pay the payments month after month. Confirm their income with their employer's HR department or ask for proof of funds. 

Collect a sizable down payment

Especially if the buyer has a low credit score, you can ask for a down payment higher than 20% as a way to lower your financial risk.

Include a late payment fee

Make sure your contract outlines a penalty for late payments, within reason. This keeps buyers motivated and provides an incentive to send payments on time. 

Ask for references

Requesting professional references can be especially beneficial for a buyer with so-so credit. It can give you peace of mind on their level of responsibility. 

Request insurance

Request that the buyer obtain both title insurance and homeowners insurance to minimize your financial risk. 

Consider the loan term

You probably don't want to do a 30-year loan term. In fact, most seller financing agreements are only for two years. A shorter term is less risky and frees up your equity, yet it gives your buyer time to improve their credit enough to secure traditional financing or wait until better interest rates are available.

Hire a lawyer

In some states, attorneys are required to oversee any real estate transaction — owner financing included. But even if you live in a state where it's not required, it's always smart to use a lawyer in a seller financing situation to ensure you retain your title and have recourse if the buyer defaults. 

Ensure property upkeep

Make sure the buyer is maintaining the property throughout the life of the financing agreement. Although the goal is for them to eventually fully purchase the home and obtain the title, if the buyer defaults at some point, you won't want to have to put a poorly maintained home back on the market. 

Talk to your attorney about putting an acceleration clause in the contract that will make the buyer find alternative financing if the property is in disrepair. This will incentivize the buyer to take good care of the home to avoid breach of contract. 

Know your foreclosure rights

In some states, the seller can initiate foreclosure proceedings if the buyer defaults on their payments. This is called 'land contract forfeiture,' and the buyer must give up their down payment and all monthly payments they've made to you so far. Their equitable title is removed as well. Depending on the state, your buyer may have a redemption period — a period of time to make good on the deal. Make sure you understand how many missed payments your state requires before you can initiate a foreclosure.