Q: What exactly is a land sales contract and what are the risks to the buyer and seller? I have a signed contract with a friend to buy one of his investment properties--a single-family house in Maryland--as an investment for myself. Originally, his lender was verbally offering 12 1/2 percent, 30-year financing, although my friend now has a 9 1/2 percent loan.
Once I became more interested, the quoted interest rate went to 13 percent and three points. I am beginning to think the lender is trying to take advantage of me. My friend has suggested a land sales contract to avoid the points and to keep his 9 1/2 percent rate. He will take back a second trust to cover his equity. This sounds like a good deal to me.
A: If you are buying this property with little or no money down, the land contract may be a good deal for you. While land contracts are very common in the western part of the United States, there are many problems and uncertainties with this kind of transaction, and I urge extreme caution before finalizing your transaction. It is clear that your seller would like to use this procedure to get around the nonassumability of his existing loan--and you, of course, would like to take advantage of the lower interest rate.
Over-simplified, the land contract--also referred to as a contract for deed or installment contract--is a legal transaction where the buyer makes a down payment and the balance of the purchase price is paid in monthly or quarterly installments. Title to the property does not turn over to the buyer until a set time, generally agreed upon by the parties.
In the absense of a specific statute (such as exists in Maryland) the parties are free to enter into any contractual arrangement they want, as long as it does not violate public policy. Generally speaking, the seller is obligated to convey title in accordance with the terms of the contract. This could be when the buyer either pays the entire purchase price in full or reaches a certain point in the transaction.
Needless to say, this raises many serious legal problems. Let us look at it from the seller's point of view first.
The seller wants to make sure that taxes will be paid when they become due. If there is a mortgage, the seller wants to be satisfied that the mortgage payments are kept current to avoid foreclosure. After all, until the deed is transferred to the buyer, the seller still holds legal title.
Additionally, the seller must be concerned about the condition of the property. Adequate safeguards must be spelled out in the contract giving the seller the right to inspect the premises periodically, and requiring the buyer to maintain insurance in the event of a fire or other hazard.
The buyer has problems also. What guarantee does the buyer have that the seller will not sell the same property fraudulently to other purchasers. It is absolutely imperative that a memorandum of the land contract sale be recorded in the jurisdiction where the land is located. Many state laws, such as Maryland, require that these contracts be recorded, but there is no universal law that requires this recording.
What arrangements will be made for the actual conveyance of the deed, when the terms of the contract have been met? If transfer is not to take place for a number of years, it is conceivable that the seller could die, or otherwise be incapacitated. It is advisable to require the seller to put the deed in escrow with a public institution or an attorney so that the escrow agent will have the absolute authority to record the deed in favor of the buyer when the conditions of the contract have been met.
Finally, we have perhaps the most serious problem, namely dealing with the existing mortgage. The reason your seller and you want to enter into this kind of transaction is to get around the language in the standard deed of trust (mortgage) that states: "If all or any part of the property or an interest therein is sold or transferred by borrower without the lender's prior written consent . . . the lender may . . . declare all the sums secured by this deed of trust to be immediately due and payable."
This is know as the nonassumability clause, also referred to as the "due on sale" clause. That clause has been determined to be against the public policy of many states. However, in the Fourth Judicial Circuit (covering Virginia and Maryland) the courts have upheld the validity of the due-on-sale clause. In the District, there have been no such rulings, and there remains considerable uncertainty as to what the District court would do if faced with a challenge to the clause.
You have to look to the language of the existing mortgage. When the seller enters into a land contract, although legal title remains with the seller, there is a conveyance of an interest to the buyer, known as "equitable title." It is my opinion that under the standard deed of trust clause, a land contract would trigger the due-on-sale clause.
No one knows for sure whether a lender will attempt to exercise the due-on-sale clause. By so exercising the clause, the lender accelerates the mortgage and calls it immediately due. Thus, from your point of view as the buyer, unless you are able to come up with alternate financing --or "cut a deal" with the lender--you may find that the property will be put up for foreclosure sale. From the seller's point of view, if a foreclosure takes place, the seller could lose his entire equity in the property. His second deed of trust would be wiped out if the first-trust holder foreclosed.
Buyers and sellers should recognize the consequences of a land sales contract. They are very valuable legal tools, but buyer and seller should go into this type of arrangement with their eyes wide open. Benny L. Kass is a Washington attorney. Write him in care of the real estate section, The Washington Post, 1150 15th St. NW, Washington 20071. For a copy of the free booklet, "A Guide to Settlement on Your New Home," send a self-addressed, stamped envelope to Benny L. Kass, 1528 18th St. NW, Washington 20036.