Land contracts, one of the hottest residential financing devices in mortgage-credit squeezed areas of the U.S., could trigger litigation here between home sellers and savings and loan associations, attorneys predict.
One District attorney who represents local S&L as well as thrift institutions in 20 other states predicts that any significant volume of land contract-financed homes here "is almost certain to bring an early court test" of the nonassumability clauses contained in standard S&L mortgages for the past 10 years.
That attorney, George Murphy, of Muldoon & Murphy, says that "on their face, land contracts appear to be a device to sidestep the acceleration (non-assumability) language" in S&L deeds of trust and mortgage agreements with borrowers. "There is no question in my mind that (the S&L industry) would challenge their legality if a lot of people started selling houses with them."
Realtors and attorneys here confirm that consumer interest in land contract home sales is rising rapidly in response to the mortgage crunch at conventional lending institutions. No one has hard data on sales volume yet, but an October survey by Advance Mortgage Corp. in the Detroit area found that the use of land contracts for primary home sales had doubled here in the span of a month.
Land contracts, common in Hawaii, California, Arizona and other western states, are a form of installment financing for the buyer by the seller. The seller and buyer custom-tailor all the details of the transaction -- down payment, terms of the loan, rate of interest, payback schedules and the like -- usually with the help of an experienced real estate attorney.
The terms can be highly favorable to the consumer in a market such as today's. The basic interest rate may be several percentage points below the going rate at S&Ls and banks; the contract can run for 30 years, or three years, or for whatever period the parties desire, with no prepayment penalities. The shorter-term contracts typically allow refinancing via conventional means whenever the market improves, or they provide for extensions of the term in case the market gets worse.
Unlike a mortgage or deed-of-trust transaction, a buyer who signs a land contract doesn't take title to the property until specified conditions are met, such as payment of 40 or 50 percent of the debt. The purchaser occupies the house following settlement as in any conventional transaction, but the seller holds the title until the specified point in the contract is reached. Should there be a default on the agreed payments, the seller has legal title to the real estate, and may retain all payments to date.
No outside lender is involved -- and that's the beauty of the technique, according to its proponents. If the purchaser doesn't have enough cash to pay the seller the full amount of his or her equity in the house, there's no need to turn to a bank or S&L. The seller can provide a second note for shorter term and higher interest rate.
The seller reaches the basic goal -- disposal of the property at an attractive price in a period when most transactions are stymied by money problems -- and gets one or more notes at high rates as a
"The land contract approach is one of the most flexible and creative open to buyers and sellers of property," said Stanley B. Brock, of the Alexandria law firm of Taylor, Clemente & Brock. "There is no reason why it shouldn't be more common here, even in times when conventional mortgage money is readily obtainable" from S&Ls and banks. Brock's firm has developed a sub-specialty in this field over the past five years, and has even copyrighted the detailed contract forms it uses for Northern Virginia sales.
The problem with all this enthusiasm for land contracts, however, is that, as attorney Murphy suggests, they may violate the "due-on-sale" clause contained in a large percentage of the mortgages here. That clause permits an S&L to demand full payment of the outstanding loan, or to adjust the interest rate to the level prevailing in the current market, if the homeowner transfers his or her interest in the property without prior written consent of the lender.
S&Ls here and in most other states value this clause highly because it inhibits long-term continuance of mortgages with low interest rates, especially those mortgages with 7 to 9 percent interest that are utter losers in a double-digit money market.
The owner of a $120,000 house with a non-assumable $60,000 mortgage at 7 1/2 percent cannot allow a new buyer to take over the payments for $60,000 because the due-on-sale clause in the deed of trust expressly prohibits it.
Land contracts, though, do not involve outright transfers of title at settlement. The seller of the same $120,000 house might well write a contract at 7 1/2 percent on the terms identical to his or her existing deed of trust, upon receipt of $60,000 in cash or notes.
The title might not transfer for years, the computerized loan collection system at the S&L wouldn't detect anything as long as the new buyer made regular payments, and purchaser and seller would both have exactly what they wanted. The existing loan would, in effect, be "assumed" or taken over in a private arrangement.
Only the S&L would be the theoretical -- or actual -- loser, depending upon your view of non-assumability clauses.
Recent court tests and legislation regarding due-on-sale provisions in a dozen states suggest that consumers may be on solid ground in thumbling their noses at mortgage lenders. But federal regulations expressly permit federally chartered S&Ls to include these provisions in their mortgage documents, and no consumer test cases have been brought here to challenge local thrift institutions on the point.
Quite possibly the challenge will be brought by an S&L -- when one discovers that a land contract "assumption" has occurred on one of its low-yield mortgages and demands immediate full payment of the loan by the shocked sellers.