REtipster does not provide legal advice. The information in this article can be impacted by many unique variables. Always consult with a qualified legal professional before taking action.
In the world of seller financing, the land contract (contract for deed) is a well-known type of lending instrument, but it has some fundamental issues that can come into play for both parties, especially if the seller/lender ever wants to sell their note to another investor.
In this conversation with Eric Scharaga, we discuss some of the reasons NOT to use this document and why you may want to consider opting for a mortgage or deed of trust instead.
Note: No part of this lesson should be interpreted as legal advice. Nobody in this conversation is a licensed attorney, and you should pursue legal advice in the state where you are working before you act on anything we discuss here.
Problem #1: You Still Own the Property
One of the first reasons not to use a land contract is that you will still own the property.
I know what you're thinking,
“Wait… this is a bad thing?”
While some sellers may see this as a good thing, property ownership is a double-edged sword.
When you still own the property, you are also responsible for any risks associated with the property, such as lawsuits or fines. And when you have this added exposure, you will want to have liability insurance to protect yourself in case of any accidents or incidents on the property, which adds another holding cost onto your plate.
Problem #2: More Difficult to Sell the Note
Another reason not to use a land contract is that it can be harder to sell your note to another investor.
Granted, not every seller intends to sell their loan, but even if this isn't part of your original plan, it's still nice to have the option if/when the need for extra liquidy arises.
If you close with a loan instrument that makes it easy to sell your note, you'll have fewer barriers if you want to liquidate your note by selling to another investor.
If you close with a land contract, selling your note won't be impossible, but it will usually be more difficult.
Additionally, transfer taxes may be associated with transferring the property, which can add extra costs.
Problem #3: Added Risk for the Borrower
If a borrower knows what's best for them, they'll usually prefer to have the property in their name.
Owning the property in their name gives the borrower more control and flexibility. Whereas, with a land contract, the buyer won't receive the title until the property is paid in full, which can limit their options.
Of course, some borrowers don't know any better, so this isn't always a disqualifier for every potential borrower, but again, the “benefit” of keeping the title in the name of the seller with a land contract isn't necessarily a big benefit, especially when you also consider the added risks that come with property ownership during the term of the loan payoff period.
Problem #4: State Laws
Some states have laws that make land contracts a very UNideal type of loan instrument for a seller-financed transaction (I'm looking at you, Texas).
There are often misconceptions about land contracts, such as the belief that you can cancel the contract and resell the property.
Many states require a foreclosure anyway, regardless of whether the title is still in the seller's name, which can take up to five years and cost up to 20%.
Problem #5: Clouded Title
When you record a land contract the right way, you're supposed to record a memorandum of land contract, which is designed to protect both the buyer and the seller in the transaction.
However, this can also cause complications in the future, especially if the borrower defaults on their loan before paying it in full, and other potential buyers will see any unresolved title issues if they do their title search.
Land Contract Alternatives
What else should you use if you don't use a land contract?
Ultimately, this is a question for your attorney (as usual), but in most states, a deed of trust or a mortgage is used with a promissory note.
How can you know whether to use a deed of trust or a mortgage?
The decision usually comes down to whether it's a judicial or non-judicial foreclosure state.
With a deed of trust, you'll have a path for non-judicial foreclosure, where the trustee can sell the property at an auction and help the lender to recoup their losses.
With a mortgage, you'll have had to foreclose through a judicial court process, but it's usually much more straightforward to navigate through this process with a mortgage than with a land contract.
How to Handle Foreclosure
Suppose you have a borrower who stops paying. What are your options?
What steps must you follow to regain control of your property?
Option 1: Deed in Lieu of Foreclosure.
Probably the fastest, easiest way to eliminate your borrower's interest in the subject property is to have them sign a new quit claim deed, transferring the property back to you.
This will only be a valid option if:
- You have an open line of communication with your borrower (they're responsive, they aren't ghosting you, and they're willing to return the property to you).
- You do a new title search and find that the property is clear of any new liens or other clouds on the title.
If both of these things are true, you can accept the quit claim deed back from the borrower and get it recorded in exchange for waiving any of your rights for a deficiency judgment against the borrower.
In other words, since the borrower is giving the property back to the seller, the seller isn't going to come after the borrower for the money they owe. The seller is taking back what is theirs, and both parties are going their separate ways.
What If You Find Title Issues?
If you do a title search and find new title issues on the property since your borrower took ownership, you probably won't even want to take the property back because you'll be inheriting all of those new title issues with the property.
In most cases, an effective way to deal with new title problems is to take the property through a judicial foreclosure because this process will wipe out most title issues.
Option 2: Foreclosure
If you can't get a deed back from the borrower with a clear title, your next step is to pursue foreclosure.
The foreclosure process will look different depending on the loan instrument used (mortgage, deed of trust, or land contract) and whether the property is in a judicial or non-judicial foreclosure state.
The judicial foreclosure process may seem daunting and complicated because, in many cases, it kinda is. But luckily, a foreclosure attorney can help you with all of this.
Don't feel like you need to carry this burden on your own. When you have a default, contact an attorney to help you.
Who should you call? Eric Scharaga has a solid list of foreclosure attorneys throughout the country. You can reach out to him and see if he has any recommendations.
Otherwise, if you do a Google search for “foreclosure attorney” or “creditor's rights attorney,” that's another way to find attorneys with this area of expertise who can probably help you figure out the next steps.
Contact Eric Scharaga at: