collateral assignment of land contract

Collateral Assignment of Contracts, Licenses, Permits, and Plans (Construction Loan) | Practical Law

Collateral Assignment of Contracts, Licenses, Permits, and Plans (Construction Loan)

Practical law standard document w-008-0125  (approx. 20 pages).

The Contractor’s Consent – A Trap for the Unwary

On private construction projects, the lender often requires that the owner/borrower obtain the written consent of the contractor to the collateral assignment of the construction contract by the owner to the lender. This permits the lender to step into the owner’s shoes with respect to the construction contract in the event of the owner’s default under the project loan documents. Unfortunately, the Consent forms developed by most lenders these days have many more serious implications for contractors.

Although the general form of the Consent is similar among lenders, the forms are becoming increasingly customized and include many terms other than just the consent to assignment. Whenever faced with such a document, a contractor must be alert and should watch for the following:

Notice of Default/Termination The Consent may require that the contractor provide written notice to the lender if there has been any default by the owner under the construction contract or if the contractor wishes to terminate the construction contract. If the contractor forgets (in the heat of the battle) to provide notice to the lender, it may render the declaration of default or termination ineffective. Failure to provide notice would also certainly impair any rights the contractor may wish to assert against the lender.

Change Order Approval Most lenders’ Consent forms require the contractor to obtain prior written approval of the lender to any change orders between the contractor and the owner. Given the lender’s responsiveness, at the very least this is an administrative annoyance, but at its worst, this is a detail that could impact the Project schedule or disrupt the contractor’s negotiations with the owner. Contractors should seek to eliminate this requirement in its entirety, but failing that, should limit its applicability to only change orders over a stated dollar amount.

Assignment Once a lender takes over a project from a defaulting owner, it may seek to assign the lender’s rights in the construction contract to a new entity. It will want to make that assignment without the contractor’s consent and will typically include a provision in the Consent form allowing it to do so. Contractors should be wary of these clauses and insist that no assignment can be made without the contractor’s prior written consent.

Mechanics’ Lien Rights Most lenders include in their Consent forms a provision in which the contractor either waives its mechanics’ lien rights on the Project or subordinates its mechanics’ lien rights to the lender’s mortgage rights. In Minnesota, we have a statute (Minn. Stat. § 337.10, Subd. 2) that may make a prepayment lien waiver unenforceable, but it is not settled whether it makes a lien subordination unenforceable. Although such subordination clauses seem unfair, especially considering that the lender likely has a title insurer insuring its priority, lenders will resist the well-advised efforts by contractors to remove the subordination provision.

Payment Upon Takeover One of the primary purposes of the Contractor’s Consent is to ensure that, if there is a default and the lender must take over an uncompleted Project, the contractor will complete the Project for the lender according to the terms of the construction contract. The typical form logically requires the lender to pay the contractor going forward from the time of lender takeover. Most forms, however, do not obligate the lender to pay the contractor any amounts unpaid at the time of takeover. This should not be acceptable to any contractor – especially one that has been required to subordinate its mechanics’ lien rights to the lender’s mortgage.

Lenders have lately been more sensitive to contractors’ concerns and have been willing to agree to cure pre-takeover defaults (including payment defaults) in addition to paying post-takeover costs. This is certainly something to be negotiated by the contractor at the time it is being asked to sign a consent form.

Conclusion Do not take the Contractor’s Consent lightly. Rarely should you accept the standard form you receive from the lender. Make it fair and protect your rights.

• assignments basic law

Assignments: The Basic Law

The assignment of a right or obligation is a common contractual event under the law and the right to assign (or prohibition against assignments) is found in the majority of agreements, leases and business structural documents created in the United States.

As with many terms commonly used, people are familiar with the term but often are not aware or fully aware of what the terms entail. The concept of assignment of rights and obligations is one of those simple concepts with wide ranging ramifications in the contractual and business context and the law imposes severe restrictions on the validity and effect of assignment in many instances. Clear contractual provisions concerning assignments and rights should be in every document and structure created and this article will outline why such drafting is essential for the creation of appropriate and effective contracts and structures.

The reader should first read the article on Limited Liability Entities in the United States and Contracts since the information in those articles will be assumed in this article.

Basic Definitions and Concepts:

An assignment is the transfer of rights held by one party called the “assignor” to another party called the “assignee.” The legal nature of the assignment and the contractual terms of the agreement between the parties determines some additional rights and liabilities that accompany the assignment. The assignment of rights under a contract usually completely transfers the rights to the assignee to receive the benefits accruing under the contract. Ordinarily, the term assignment is limited to the transfer of rights that are intangible, like contractual rights and rights connected with property. Merchants Service Co. v. Small Claims Court , 35 Cal. 2d 109, 113-114 (Cal. 1950).

An assignment will generally be permitted under the law unless there is an express prohibition against assignment in the underlying contract or lease. Where assignments are permitted, the assignor need not consult the other party to the contract but may merely assign the rights at that time. However, an assignment cannot have any adverse effect on the duties of the other party to the contract, nor can it diminish the chance of the other party receiving complete performance. The assignor normally remains liable unless there is an agreement to the contrary by the other party to the contract.

The effect of a valid assignment is to remove privity between the assignor and the obligor and create privity between the obligor and the assignee. Privity is usually defined as a direct and immediate contractual relationship. See Merchants case above.

Further, for the assignment to be effective in most jurisdictions, it must occur in the present. One does not normally assign a future right; the assignment vests immediate rights and obligations.

No specific language is required to create an assignment so long as the assignor makes clear his/her intent to assign identified contractual rights to the assignee. Since expensive litigation can erupt from ambiguous or vague language, obtaining the correct verbiage is vital. An agreement must manifest the intent to transfer rights and can either be oral or in writing and the rights assigned must be certain.

Note that an assignment of an interest is the transfer of some identifiable property, claim, or right from the assignor to the assignee. The assignment operates to transfer to the assignee all of the rights, title, or interest of the assignor in the thing assigned. A transfer of all rights, title, and interests conveys everything that the assignor owned in the thing assigned and the assignee stands in the shoes of the assignor. Knott v. McDonald’s Corp ., 985 F. Supp. 1222 (N.D. Cal. 1997)

The parties must intend to effectuate an assignment at the time of the transfer, although no particular language or procedure is necessary. As long ago as the case of National Reserve Co. v. Metropolitan Trust Co ., 17 Cal. 2d 827 (Cal. 1941), the court held that in determining what rights or interests pass under an assignment, the intention of the parties as manifested in the instrument is controlling.

The intent of the parties to an assignment is a question of fact to be derived not only from the instrument executed by the parties but also from the surrounding circumstances. When there is no writing to evidence the intention to transfer some identifiable property, claim, or right, it is necessary to scrutinize the surrounding circumstances and parties’ acts to ascertain their intentions. Strosberg v. Brauvin Realty Servs., 295 Ill. App. 3d 17 (Ill. App. Ct. 1st Dist. 1998)

The general rule applicable to assignments of choses in action is that an assignment, unless there is a contract to the contrary, carries with it all securities held by the assignor as collateral to the claim and all rights incidental thereto and vests in the assignee the equitable title to such collateral securities and incidental rights. An unqualified assignment of a contract or chose in action, however, with no indication of the intent of the parties, vests in the assignee the assigned contract or chose and all rights and remedies incidental thereto.

More examples: In Strosberg v. Brauvin Realty Servs ., 295 Ill. App. 3d 17 (Ill. App. Ct. 1st Dist. 1998), the court held that the assignee of a party to a subordination agreement is entitled to the benefits and is subject to the burdens of the agreement. In Florida E. C. R. Co. v. Eno , 99 Fla. 887 (Fla. 1930), the court held that the mere assignment of all sums due in and of itself creates no different or other liability of the owner to the assignee than that which existed from the owner to the assignor.

And note that even though an assignment vests in the assignee all rights, remedies, and contingent benefits which are incidental to the thing assigned, those which are personal to the assignor and for his sole benefit are not assigned. Rasp v. Hidden Valley Lake, Inc ., 519 N.E.2d 153, 158 (Ind. Ct. App. 1988). Thus, if the underlying agreement provides that a service can only be provided to X, X cannot assign that right to Y.

Novation Compared to Assignment:

Although the difference between a novation and an assignment may appear narrow, it is an essential one. “Novation is a act whereby one party transfers all its obligations and benefits under a contract to a third party.” In a novation, a third party successfully substitutes the original party as a party to the contract. “When a contract is novated, the other contracting party must be left in the same position he was in prior to the novation being made.”

A sublease is the transfer when a tenant retains some right of reentry onto the leased premises. However, if the tenant transfers the entire leasehold estate, retaining no right of reentry or other reversionary interest, then the transfer is an assignment. The assignor is normally also removed from liability to the landlord only if the landlord consents or allowed that right in the lease. In a sublease, the original tenant is not released from the obligations of the original lease.

Equitable Assignments:

An equitable assignment is one in which one has a future interest and is not valid at law but valid in a court of equity. In National Bank of Republic v. United Sec. Life Ins. & Trust Co. , 17 App. D.C. 112 (D.C. Cir. 1900), the court held that to constitute an equitable assignment of a chose in action, the following has to occur generally: anything said written or done, in pursuance of an agreement and for valuable consideration, or in consideration of an antecedent debt, to place a chose in action or fund out of the control of the owner, and appropriate it to or in favor of another person, amounts to an equitable assignment. Thus, an agreement, between a debtor and a creditor, that the debt shall be paid out of a specific fund going to the debtor may operate as an equitable assignment.

In Egyptian Navigation Co. v. Baker Invs. Corp. , 2008 U.S. Dist. LEXIS 30804 (S.D.N.Y. Apr. 14, 2008), the court stated that an equitable assignment occurs under English law when an assignor, with an intent to transfer his/her right to a chose in action, informs the assignee about the right so transferred.

An executory agreement or a declaration of trust are also equitable assignments if unenforceable as assignments by a court of law but enforceable by a court of equity exercising sound discretion according to the circumstances of the case. Since California combines courts of equity and courts of law, the same court would hear arguments as to whether an equitable assignment had occurred. Quite often, such relief is granted to avoid fraud or unjust enrichment.

Note that obtaining an assignment through fraudulent means invalidates the assignment. Fraud destroys the validity of everything into which it enters. It vitiates the most solemn contracts, documents, and even judgments. Walker v. Rich , 79 Cal. App. 139 (Cal. App. 1926). If an assignment is made with the fraudulent intent to delay, hinder, and defraud creditors, then it is void as fraudulent in fact. See our article on Transfers to Defraud Creditors .

But note that the motives that prompted an assignor to make the transfer will be considered as immaterial and will constitute no defense to an action by the assignee, if an assignment is considered as valid in all other respects.

Enforceability of Assignments:

Whether a right under a contract is capable of being transferred is determined by the law of the place where the contract was entered into. The validity and effect of an assignment is determined by the law of the place of assignment. The validity of an assignment of a contractual right is governed by the law of the state with the most significant relationship to the assignment and the parties.

In some jurisdictions, the traditional conflict of laws rules governing assignments has been rejected and the law of the place having the most significant contacts with the assignment applies. In Downs v. American Mut. Liability Ins. Co ., 14 N.Y.2d 266 (N.Y. 1964), a wife and her husband separated and the wife obtained a judgment of separation from the husband in New York. The judgment required the husband to pay a certain yearly sum to the wife. The husband assigned 50 percent of his future salary, wages, and earnings to the wife. The agreement authorized the employer to make such payments to the wife.

After the husband moved from New York, the wife learned that he was employed by an employer in Massachusetts. She sent the proper notice and demanded payment under the agreement. The employer refused and the wife brought an action for enforcement. The court observed that Massachusetts did not prohibit assignment of the husband’s wages. Moreover, Massachusetts law was not controlling because New York had the most significant relationship with the assignment. Therefore, the court ruled in favor of the wife.

Therefore, the validity of an assignment is determined by looking to the law of the forum with the most significant relationship to the assignment itself. To determine the applicable law of assignments, the court must look to the law of the state which is most significantly related to the principal issue before it.

Assignment of Contractual Rights:

Generally, the law allows the assignment of a contractual right unless the substitution of rights would materially change the duty of the obligor, materially increase the burden or risk imposed on the obligor by the contract, materially impair the chance of obtaining return performance, or materially reduce the value of the performance to the obligor. Restat 2d of Contracts, § 317(2)(a). This presumes that the underlying agreement is silent on the right to assign.

If the contract specifically precludes assignment, the contractual right is not assignable. Whether a contract is assignable is a matter of contractual intent and one must look to the language used by the parties to discern that intent.

In the absence of an express provision to the contrary, the rights and duties under a bilateral executory contract that does not involve personal skill, trust, or confidence may be assigned without the consent of the other party. But note that an assignment is invalid if it would materially alter the other party’s duties and responsibilities. Once an assignment is effective, the assignee stands in the shoes of the assignor and assumes all of assignor’s rights. Hence, after a valid assignment, the assignor’s right to performance is extinguished, transferred to assignee, and the assignee possesses the same rights, benefits, and remedies assignor once possessed. Robert Lamb Hart Planners & Architects v. Evergreen, Ltd. , 787 F. Supp. 753 (S.D. Ohio 1992).

On the other hand, an assignee’s right against the obligor is subject to “all of the limitations of the assignor’s right, all defenses thereto, and all set-offs and counterclaims which would have been available against the assignor had there been no assignment, provided that these defenses and set-offs are based on facts existing at the time of the assignment.” See Robert Lamb , case, above.

The power of the contract to restrict assignment is broad. Usually, contractual provisions that restrict assignment of the contract without the consent of the obligor are valid and enforceable, even when there is statutory authorization for the assignment. The restriction of the power to assign is often ineffective unless the restriction is expressly and precisely stated. Anti-assignment clauses are effective only if they contain clear, unambiguous language of prohibition. Anti-assignment clauses protect only the obligor and do not affect the transaction between the assignee and assignor.

Usually, a prohibition against the assignment of a contract does not prevent an assignment of the right to receive payments due, unless circumstances indicate the contrary. Moreover, the contracting parties cannot, by a mere non-assignment provision, prevent the effectual alienation of the right to money which becomes due under the contract.

A contract provision prohibiting or restricting an assignment may be waived, or a party may so act as to be estopped from objecting to the assignment, such as by effectively ratifying the assignment. The power to void an assignment made in violation of an anti-assignment clause may be waived either before or after the assignment. See our article on Contracts.

Noncompete Clauses and Assignments:

Of critical import to most buyers of businesses is the ability to ensure that key employees of the business being purchased cannot start a competing company. Some states strictly limit such clauses, some do allow them. California does restrict noncompete clauses, only allowing them under certain circumstances. A common question in those states that do allow them is whether such rights can be assigned to a new party, such as the buyer of the buyer.

A covenant not to compete, also called a non-competitive clause, is a formal agreement prohibiting one party from performing similar work or business within a designated area for a specified amount of time. This type of clause is generally included in contracts between employer and employee and contracts between buyer and seller of a business.

Many workers sign a covenant not to compete as part of the paperwork required for employment. It may be a separate document similar to a non-disclosure agreement, or buried within a number of other clauses in a contract. A covenant not to compete is generally legal and enforceable, although there are some exceptions and restrictions.

Whenever a company recruits skilled employees, it invests a significant amount of time and training. For example, it often takes years before a research chemist or a design engineer develops a workable knowledge of a company’s product line, including trade secrets and highly sensitive information. Once an employee gains this knowledge and experience, however, all sorts of things can happen. The employee could work for the company until retirement, accept a better offer from a competing company or start up his or her own business.

A covenant not to compete may cover a number of potential issues between employers and former employees. Many companies spend years developing a local base of customers or clients. It is important that this customer base not fall into the hands of local competitors. When an employee signs a covenant not to compete, he or she usually agrees not to use insider knowledge of the company’s customer base to disadvantage the company. The covenant not to compete often defines a broad geographical area considered off-limits to former employees, possibly tens or hundreds of miles.

Another area of concern covered by a covenant not to compete is a potential ‘brain drain’. Some high-level former employees may seek to recruit others from the same company to create new competition. Retention of employees, especially those with unique skills or proprietary knowledge, is vital for most companies, so a covenant not to compete may spell out definite restrictions on the hiring or recruiting of employees.

A covenant not to compete may also define a specific amount of time before a former employee can seek employment in a similar field. Many companies offer a substantial severance package to make sure former employees are financially solvent until the terms of the covenant not to compete have been met.

Because the use of a covenant not to compete can be controversial, a handful of states, including California, have largely banned this type of contractual language. The legal enforcement of these agreements falls on individual states, and many have sided with the employee during arbitration or litigation. A covenant not to compete must be reasonable and specific, with defined time periods and coverage areas. If the agreement gives the company too much power over former employees or is ambiguous, state courts may declare it to be overbroad and therefore unenforceable. In such case, the employee would be free to pursue any employment opportunity, including working for a direct competitor or starting up a new company of his or her own.

It has been held that an employee’s covenant not to compete is assignable where one business is transferred to another, that a merger does not constitute an assignment of a covenant not to compete, and that a covenant not to compete is enforceable by a successor to the employer where the assignment does not create an added burden of employment or other disadvantage to the employee. However, in some states such as Hawaii, it has also been held that a covenant not to compete is not assignable and under various statutes for various reasons that such covenants are not enforceable against an employee by a successor to the employer. Hawaii v. Gannett Pac. Corp. , 99 F. Supp. 2d 1241 (D. Haw. 1999)

It is vital to obtain the relevant law of the applicable state before drafting or attempting to enforce assignment rights in this particular area.

Conclusion:

In the current business world of fast changing structures, agreements, employees and projects, the ability to assign rights and obligations is essential to allow flexibility and adjustment to new situations. Conversely, the ability to hold a contracting party into the deal may be essential for the future of a party. Thus, the law of assignments and the restriction on same is a critical aspect of every agreement and every structure. This basic provision is often glanced at by the contracting parties, or scribbled into the deal at the last minute but can easily become the most vital part of the transaction.

As an example, one client of ours came into the office outraged that his co venturer on a sizable exporting agreement, who had excellent connections in Brazil, had elected to pursue another venture instead and assigned the agreement to a party unknown to our client and without the business contacts our client considered vital. When we examined the handwritten agreement our client had drafted in a restaurant in Sao Paolo, we discovered there was no restriction on assignment whatsoever…our client had not even considered that right when drafting the agreement after a full day of work.

One choses who one does business with carefully…to ensure that one’s choice remains the party on the other side of the contract, one must master the ability to negotiate proper assignment provisions.

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Land Contract: What It Is & How It Works

Updated: Sep 27, 2021, 10:04am

For the buyer, a land contract is an alternative to getting a mortgage or paying cash to buy a home. For the owner, it’s a way to sell property a bank may not want to finance. It can also be a way for a seller to expand the pool of potential buyers to include people who might not qualify for a traditional or government-backed home loan.

What Is a Land Contract?

A land contract is a legal agreement where the owner finances the buyer’s purchase of a piece of real estate. Despite its name, a land contract isn’t necessarily an agreement to purchase a vacant parcel (though it can be). It’s often a contract to buy a house plus the land under and around it.

Both parties make compromises under a land contract. The seller won’t get paid in full when the deal closes, like they would if the buyer got a mortgage or paid cash. Instead, they’ll get paid over time—if the buyer makes all the payments. The buyer often unknowingly sacrifices the legal protections they’d get with a rental agreement or mortgage finances.

Land contracts don’t have to be a bad deal for buyers. But they do have a decades-long history of being more advantageous for sellers than buyers and have been used for discriminatory practices. You should be keenly aware of this context if you’re thinking about entering into a land contract.

How Does a Land Contract Work?

The laws governing land contracts vary by state, but here’s how a land contract is generally supposed to work.

A buyer and seller draw up a contract that includes the following information:

• A legal description of the property
• Names and addresses of the buyer and seller
• Purchase price
• Down payment
• Interest rate
• Payment schedule (including an amortization schedule that shows how much of each payment goes to principal and how much goes to interest)
• Whether the property has any liens against it (for a mortgage or unpaid taxes)
• Whether the buyer must make a balloon payment (a lump sum to pay off the remaining principal at the end of the loan term)
• Whether the loan has a prepayment penalty (a fee for paying off the loan early)
• How the seller will penalize the buyer for late payments
• How much time the buyer has to catch up on a late payment
• Who is responsible for maintenance, repairs, taxes and insurance
• A requirement that the seller provide evidence of title
• A requirement that the seller legally record the agreement

After both parties sign the contract, the buyer gets an equitable title or a general warranty deed . These documents protect the buyer by allowing them to accumulate equity in the property and by preventing the seller from taking out new loans against the property or selling the property to anyone else. The buyer also gets the right to occupy and improve the property.

It’s important to note that the seller can also be called a vendor, and the buyer can be called the vendee.

The seller holds the legal title until the buyer pays off the property. This, combined with a contract (that may not spell out everything listed above), is why many buyers get fleeced in land contract deals. This is discussed further below. But first, it’s important to understand the types of land contracts.

Types of Contracts

A land contract may sound similar to a lease with an option to buy (purchase option) or rent-to-own agreement , but it’s not the same thing. A land contract is an agreement to purchase, whereas a lease or rent option is not.

Land contracts can go by many names:

• Land contract of sale
• Land sale contract
• Real estate sales contract
• Land installment contract
• Installment sales contract
• Agreement to convey
• Agreement for purchase and sale
• Contract for deed
• Articles of agreement for warranty deed
• Executory contract
• Contract for sale
• Poor man’s mortgage

Under a land contract, the buyer does become the owner once the land contract is signed. But the down payment under a land contract works like the nonrefundable option fee paid with a purchase option contract. Most importantly, in any of these arrangements, not having the cash or financing to complete the transaction at the end of the term means the buyer loses a lot of money and has to find another place to live.

Negotiation Process

Though state law may lay out certain requirements for land contracts, the terms are largely up to the buyer and seller. The buyer in a land contract might assume the seller has all the power, but that’s not true. They may have more money and more resources. But buyers can work toward leveling the playing field by knowing their rights and their options for protecting themselves.

Buyers should ask for certain protections and get them in writing in the contract. They should also seek the assistance of an attorney (preferably one who specializes in real estate) who does not represent the seller. A buyer considering seller financing may not have the money to hire an attorney, of course. Free assistance may be available from a local law clinic, legal aid society or nonprofit housing counseling agency. By not running the contract by a legal expert, you could stand to lose a great deal.

Check out the National Consumer Law Center’s key recommendations for how the Consumer Financial Protection Bureau regulates land contracts nationwide, though it is limited. These suggestions highlight the lack of federal (and often state) consumer protections for these deals. They also offer guidance on how you should seek to protect yourself as a buyer if you want to proceed with a home purchase using a land contract.

Land Contract Negotiations That Help Protect Buyers

If you are considering a land contract, there are a number of steps you can take to better protect yourself during the negotiations process.

• Monthly cost . When negotiating the monthly cost of a land contract, keep in mind that on top of principal and interest, you will be paying for taxes, insurance, maintenance and repairs. Ask yourself: Is the principal and interest reasonable and affordable after you add on these costs? Do you know how much they will be?
• Title search . It’s important to hire a reputable title company to do a title search and issue an owner’s title insurance policy before signing a land contract. Without these, you’re taking a major risk that someone other than the seller (whether the seller knows it or not) may have a claim to the property. That claim could threaten your ownership.
• Escrow service . Another smart way to protect yourself as the buyer in a land contract deal is to use an escrow service, attorney or financial institution as a neutral third party to hold the property’s deed during the payment period. By placing the deed in escrow, the seller shows good faith that they do intend to transfer the deed to the buyer once the buyer makes all the agreed-upon payments. At the same time, the escrow service protects the seller and will return the deed if the buyer does not pay as agreed.
• Appraisal . To make sure you’re paying a fair price for the home, order an independent, professional home appraisal . You’ll pay a few hundred dollars for the assurance that you’re not overpaying for the property. At a minimum, ask a local real estate agent if they’d be willing to give you their opinion on the home’s value.
• Home inspection . To make sure the home is in safe and sound condition, get a professional home inspection (another few hundred dollars). Land contract homes are sometimes in dreadful condition. You can also check with the local property tax assessor to see what the assessed value is for property tax purposes, and find out whether the property’s taxes are paid up. Assessed value is not the same as market value , however.
• Legal recording . The seller should file a short summary of the land contract, called a memorandum of land contract, with the city and county where the property lies. This document should include the buyer’s and seller’s names and a legal description of the property. It should be signed by both parties and witnessed by a notary. These steps formalize the agreement and make its existence a matter of public record to protect the buyer’s interest in the property. Your state may even require it.

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Buyer Beware

Sometimes the people or companies selling properties via land contract don’t have the buyer’s best interests in mind. Do an online search for “land contract” and the name of your state, and another search for “land contract” and the seller’s name, to look for red flags.

There are many land contract horror stories. To summarize them, the National Consumer Law Center says land contracts “allow investors to avoid responsibility for property upkeep while churning successive would-be homeowners through a property they could not legally rent.”

Land contracts are often marketed to people of color, immigrants and low-income individuals who can’t obtain traditional financing but can potentially set them up to lose money and their home.

How? Land contracts often make it all-too-easy for buyers to lose their money and equity they’ve put into the home. For instance, a land contract with a balloon payment (similar to a balloon mortgage ) might be impossible for a buyer with low income to pay off or refinance when the time comes.

Along the way, the buyer could lose the home if they’re late on a single payment. Agreements often favor sellers and make it easy for them to evict or foreclose on buyers. In Ohio, the seller can bring court action against a delinquent buyer after just 40 days. For traditional banks and mortgages, it typically takes more than 90 days of delinquency.

Besides that, the seller might offer a land contract even if they don’t own the property free and clear and are still paying off a mortgage. Whie not illegal, one potential problem is that the lender can require the loan to be immediately paid off in full if the property’s owner changes hands. Another problem is that the seller could stop paying the mortgage while continuing to collect the buyer’s payments.

In Ohio, at least, the buyer is allowed to step in and make the seller’s mortgage payments if the seller stops paying. Those payments then count toward the buyer’s land contract installment payments. But this law assumes the buyer knows what’s going on.

Land Contract Alternatives

Rather than signing a land contract, a buyer who is short on cash and/or lacking good credit may be better off renting instead of buying , while saving up a down payment and improving their credit. Even without a down payment—or with a down payment as low as 3%—you can qualify for a low-down-payment conventional mortgage and possibly even get down payment assistance .

Another option is seeking a mortgage from a portfolio lender or credit union that offers more flexible underwriting standards. These lenders don’t have to follow the rules that Fannie Mae, Freddie Mac or the Federal Housing Association (FHA) lay out. They might have an option that would work for you and offer better terms and legal protections than a land contract.

Pros and Cons of Land Contracts

A land contract can mutually benefit the buyer and seller when both parties act in good faith and take the right steps to legally protect themselves. However, since it’s a less common way of selling property, land contracts come with fewer consumer legal protections than a traditional property sale. Whether you’re considering buying or selling a property with a land contract, it’s important to understand the pros and cons before deciding whether to proceed with a deal.

• Financing can be easier to obtain because the terms can be anything that works for the buyer and seller.
• It provides a way to buy a low-cost property when a small-dollar mortgage isn’t an option.
• The buyer won’t have to pay a mortgage origination fee, and other closing costs are optional (but recommended).
• It can potentially be refinanced with a traditional mortgage after the buyer improves their credit and saves up a down payment.
• It can be faster than buying a home with a mortgage.
• The seller may be able to earn a high rate of return.
• A buyer who can’t get traditional financing may not find a seller offering a land contract on favorable terms. Land contract interest rates may be much higher than conventional mortgage rates .
• The buyer could lose the home if the seller goes bankrupt, dies, is delinquent on taxes or stops paying the mortgage.
• State laws may not provide strong protections for the buyer in a land contract deal.
• For the seller, it can take a long time and/or considerable expense to foreclose on a non-paying buyer, depending on state law. While court action may be initiated within as few as 40 days, completing the trial could take a year or longer.
• Refinancing with a mortgage may not be possible for various reasons (property is in poor condition, buyer’s credit isn’t good enough, home value is too low, etc.).
• The buyer may not be able to use the land contract as collateral for another loan (like a home equity loan ) and may not be able to assign or transfer their interest in the property until the contract is satisfied.

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Amy Fontinelle is a freelance writer, researcher and editor who brings a journalistic approach to personal finance content. Since 2004, she has worked with lenders, real estate agents, consultants, financial advisors, family offices, wealth managers, insurance companies, payment companies and leading personal finance websites. Amy also has extensive experience editing academic papers and articles by professional economists, including eight years as the production manager of an economics journal.

Rachel Witkowski is an award-winning journalist whose 20-year career spans a wide range of topics in finance, government regulation and congressional reporting. Ms. Witkowski has spent the last decade in Washington, D.C., reporting for publications including The Wall Street Journal, American Banker and Bankrate. Ms. Witkowski's deep knowledge of government and policy aided a series of investigative stories that triggered congressional hearings on employee claims of discrimination at a federal agency and how indirect auto lenders were being reviewed by regulators.