Realtors and lawyers here are beginning to push home buyers and sellers into a legitimate but potentially controversial form of real estate finance -- land contracts -- as conventional mortgage sources dry up.
Real estate brokers from Frederick, Md., to Alexandria predict that there will be a major upsurge in use of the so-called "contract-for-deed" or land contract technique because it requires no participation by traditional lending institutions. The technique is one of the oldest but least-known forms of real estate finance. It was brought into play during the 1973-74 recession, but there are indications that it may be coming into greater use now.
Lawyers for savings and loan associations in this area and elsewhere, however, aren't enthusiastic about the prospect of widespread land contract purchases of homes S&Ls have already financed, and could try to block the trend before it assumes national proportions.
A land contract is a sales agreement between a property owner and a purchaser calling for specified conditions -- often payment of a set percentage of the principal debt plus interest -- to be fulfilled before title changes hands. Unlike a mortgage or deed of trust, where title to a home or a piece of property is transferred to the purchaser or a trustee, in a land contract the title remains with the seller until the predefined payments are made.
If the payments aren't completed, the seller keeps not only the property but may retain all or some of the payments already made, depending upon state law.
Most common in sales of small parcels of land to installment buyers who can afford only small down payments, the technique is a form of seller financing. An owner of a tract of land, for example, can cut up his holdings into small pieces and sell off each without involving an outside lender by agreeing to take payment from purchasers over a five- or 10-year period.
The buyers might be required to put up a 10 or 15 percent down payment, and then pay the balance to the seller over the specified number of years in monthly installments. To protect himself against default on each parcel, the seller draws up a contract in which both parties agree that legal title to the land will remain in his hands until all or a specified portion of the buyer's debt is paid.
Land contracts involving sales of houses are rare in the eastern part of the United States, but more common in California and some midwestern states. Mortgages and deeds of trust are the preferred financing vehicle for homes throughout the country because they extricate the seller rapidly from the transaction and normally bring in highly specialized lenders -- S&Ls, mutual savings banks, mortgage bankers and credit unions -- with regulated business procedures and forms.
Land contracts, by comparison, tend to be highly customized, variable according to terms from one purchase to another, and are loosely regulated, if at all. Most states define the minimum legal boundaries within which such contracts must be written -- particularly the point at which title must be transferred from seller to buyer -- but otherwise leave the terms up to the participants.
The growth in interest in land contracts in recent weeks, real estate brokers and lawyers report, is the direct result of the credit shortage now confronting borrowers at S&Ls and savings banks. Rather than watching buyers line up for loans carrying 13 and 14 percent interest rates and requiring huge down payments and big commitment fees in cash up front, real estate brokers are urging their clients to sell properties via land contracts.
The seller of a $100,000 house in Northern Virginia, for instance, might be able to offer a prospective buyer a land contract calling for 10 to 20 percent down and 11 percent interest over a five- to 25-year term. At any time during the term that the buyer could obtain better financing from a bank or S&L, the contract would permit full payment of the remaining principal, and the title would pass to the buyer.
Meanwhile, the buyer would have a publicly recorded and legally enforceable claim to the title of the property, would occupy the house and would for most practical purposes "own" it. The buyer would also have saved hundreds or even thousands of dollars in lender's fees and closing costs.
The seller would have the price he wanted for his house, retain title to the property until all his conditions were fulfilled, own a note bearing 11 percent interest, and in all probability, could expect an early payoff of the full debt.
Illustrative of the mushrooming interest in this technique is the response received to newspaper ads placed last weekend by the Alexandria law firm of Taylor, Clemente & Brock for a seminar for realty brokers on land contracts. Partner STANLEY B. Brock said that the Nov. 15 seminars' 500-person capacity was virtually sold out within the first three days after the ads ran. Realtors in Maryland, the District and elsewhere have contacted him seeking seminars in their jurisdictions, and "the depth of interest out there is incredible" because of the credit crunch, Brock said.
One problem with land contracts on houses, however, he conceded, is that they run the risk of angering conventional lenders whose existing loans on properties are non-assumable.
Since successful land contracts on many homes require that the existing financing be left undisturbed -- with the purchaser, in effect, taking over the payments on the seller's mortgage without any notification or clearance sought from the S&L that made the loan in the first place -- some lenders feel that the technique is simply a method of getting around their prohibitions against assumptions at original interest rates.
Next: How a land-contract-financed home sale works, and what D.C.-area lenders may do to block the technique.