The contract begins with the "parties"- the people (and their addresses) who are entering into the contract. The "Seller" (Vendor) is the person who sold the property and is usually listed first. The "Purchaser" (Vendee) is the one purchasing the property and is usually listed after the Seller.
The date of the Contract is here at the beginning as well. Interest starts to "accrue" (begins being owed to the Seller) starting from the date typed in, at the top of the contract. Consequently, when the first payment is due, one month's interest is usually already owed, since it is paid in arrears.
The Seller agrees to convey (sell) to the Purchaser only, a carefully described parcel of land. This description must be exact. When the purchase is completed and paid off, this should match the description on the deed. The city, village, or township of the property is noted, together with the county and state.
Along with the actual "earth" sold, the Seller also conveys such things as any buildings, easements, tenements, improvements and appurtenances. In short, the Seller conveys everything that is permanently affixed to the property.
This area should contain all the figures and dates:
Total purchase price, down payment, beginning balance remaining (the purchase price minus the down payment), monthly payment (or annual or semi-annual payment), an interest rate (usually stated in terms of an annual rate), the date of the "balloon" payment (if any), and date that the first payment is due.
Purchase Price - The Purchase price (sometimes referred to as "consideration") is negotiated between the Seller and the Purchaser. Properties sold on a land contract often sell for more than properties that are sold for cash because the Seller provides the all-important financing.
Down Payment - The down payment is usually 10% to 20% of the purchase price. From the standpoint as the Seller, the bigger the down payment the better. It represents money that does not have to be collected in the uncertain future and it also represents the Purchaser's commitment to the property. Sometimes, non-cash down payments (barter items such as used cars, snowmobiles, applied rent, etc.) are used as a down payment. This can be a very creative way to structure a sale!
Balance Remaining - Initially, this amount is the purchase price minus the down payment. The balance remaining will go down each month with the payments made by the Purchaser. An amortization schedule shows how the balance will be reduced if monthly payments are made on time.
Monthly Payment - The monthly payment is usually about 1% of the beginning balance. If after the down payment the Seller is owed $20,000 by the Purchaser, the monthly payment will probably be in the neighborhood of $220. The smaller the monthly payment, the longer it will take to pay off the land contract and the larger the monthly payment the faster the contract can be paid off.
Payment Due Date - This is the date when the first payment is due and usually the day of the month each consecutive payment is due.
Grace Period - A grace period in some contracts permits the Purchaser a few days each month during which he or she may fail to make payments and not be considered in default. Some contracts provide for a late fee if the payment is not received on time or within the grace period. Grace periods and/or late fee clauses are usually typed in as miscellaneous provisions at the end of the land contract. Many people mistake the last day of the grace period as the payment due date. Remember that even though a late fee you is not charged, the payment is still late.
Balloon Payment - If a contract contains a clause that reads something like, "the entire purchase price and interest shall be fully paid within 5 years from the date hereof, anything herein to the contrary notwithstanding," then there is what is known as a "balloon" in the contract (a five year balloon, in this example). A balloon payment is the term used for a lump sum, final payment on the contract. Balloon clauses usually call for the final payment to be made on a specified date. If the Purchaser fails to make a balloon payment when required, this will constitute a default on the contract.
Interest Rate - The interest rate is usually stated in annual terms, (e.g., 11%). When recording each payment made, interest is calculated for the payment period (usually monthly) by multiplying the interest rate by the balance due and then dividing this annual interest amount by the number of payments to be made each year. This number (total interest for the period) is then deducted from the payment. The rest of the payment is known as the principal portion of the payment and is deducted from the remaining principal balance on the contract.
It's not as confusing as it sounds. Lets look at the following example:
- Consider a land contract that has a sale price of $25,000,
- A down payment of $2,000,
- A remaining balance of $23,000, payable with monthly payments of $250 at 11%.
- The interest portion of the first payment will be $210.83 ($23,000 X .11 ¸ 12 payments per year)
- The principal portion of the payment will be $39.17 ($250 - 210.83).
- The remaining principal balance on the contract after the first payment will then be $22,960.83 ($23,000 - $39.17).
The person responsible for making tax and insurance payments can vary depending on the terms of the land contract. The three most common ways to handle the payments of taxes and insurance on the property are as follows:
1. The Purchaser pays taxes and insurance.
2. The Seller pays taxes and insurance but then adds the amounts paid back to the balance on the contract.
3. The Purchaser makes monthly contributions to an escrow account held by the Seller and the Seller pays taxes and insurance out of this account.
Method 1: Purchaser pays the Taxes and Insurance
- Most often the Purchaser is responsible for paying the taxes and insurance on the property. A typical clause in a land contract where the Purchaser pays the taxes and insurance reads something like this:
- "The Purchaser agrees to pay all taxes and assessments hereafter levied on said premises before any penalty for non-payment attaches thereto and submit receipts to Seller upon request as evidence of payment thereof; also at all times to keep the buildings now or hereafter on the premises insured against loss and damage in a manner to an amount approved by the Seller and to deliver the policies as issued by the Seller and to deliver the policies as issued to the Seller with the premiums fully paid."
Method 2: Seller Pays and Adds Amounts Spent Back to Contract Balance
- Since failure to pay either the tax or the insurance bills can seriously jeopardize the value of the property securing the land contract (imagine trying to collect payments on an uninsured home that just burned down!), some Sellers insist on paying the tax and insurance bills themselves. After paying the bills, the Sellers just add the costs of insurance and taxes back onto the balance of the land contract at the time that the bills are paid. Contracts of this type are sometimes referred to as "Add Backs".
- Under this option, the monthly payment will be supplemented with an amount to cover approximately one-twelfth of the estimated taxes and insurance. These larger payments (larger, that is, than they would be if they covered principal and interest amounts only) are treated just as if the entire amount of each payment was for principal and interest
- This makes the balance on the contract drop more quickly than it normally would. However, when the tax and insurance bills come to the Seller, the Seller pays them and adds the amounts spent to the balance due on the land contract. Thus, the balance on the land contract, after having been reduced each month more than it normally would be because of the larger payments, is re-adjusted upward when the amounts for taxes and insurance are added back to the contract balance.
- A typical clause in a contract where the Seller pays the taxes and insurance and adds them back to the contract reads something like this:
"The Purchaser is to pay monthly, in addition to the monthly payment hereinbefore stipulated, the sum of $__________, which is an estimate of the monthly cost of taxes, special assessments, and insurance premiums for the land, which shall be credited by the Seller on the unpaid principal balance owed on the contract. If Purchaser is not in default under the terms of the contract, Seller shall pay for Purchaser's account the taxes, special assessments and insurance premiums mentioned above when due and before any penalty attaches, and submit receipts therefore to Purchaser upon demand. The amounts so paid shall be added to the principal balance of this contract."
Method 3: Seller Pays Taxes and Insurance out of Amounts Put in Escrow
- A third way to have taxes and insurance handled, similar to Method 2, is for the Purchaser to pay approximately one-twelfth of the estimated taxes and insurance along with each monthly payment. The Seller then sets this extra part of the payment aside each month into what is called an "escrow account" to pay the tax and insurance bills as they arise.
If the escrow account is ever too low to pay the bills, the Seller notifies the Purchaser and a new, larger escrow payment is included along with the next monthly payment.
- A typical clause in a contract where the Seller collects an additional sum of money and deposits it into a separate account (called an escrow account) reads something like this:
"The Purchaser is to pay monthly, in addition to the monthly payment hereinbefore stipulated, the sum of $__________, which is an estimate of the monthly cost of the taxes, special assessments, and insurance premiums for the land, which shall be deposited in a non-interest-bearing account
It is the Purchaser's duty to protect the value of the property he or she is buying until it is paid in full. This clause is important because the value of the property is what keeps the Purchaser making payments. If the Purchaser ever defaults and suffers foreclosure, it is the value of the property that should enable Seller to re-sell without a loss.
Most contracts require the Purchaser to notify the Seller in writing before the Purchaser or any third party commits waste (neglects the property or allows it to be used in a way that lessens its value) or removes, changes or demolishes any buildings or improvements on the premises in a way which may diminish the property's value.
After the Purchaser makes the final payment on the contract without default, the Seller must convey the property by signing a Deed to the property.
At the time of delivery of the Deed, the Seller often also delivers an abstract of title or a policy of title insurance showing that the property is free and clear from any lien that the Seller may have remaining on the property. Which person that will pay for the cost of the insurance should be agreed upon when the terms of the purchase are made.
It is the Purchaser's responsibility to record the Deed. The fee is nominal and recording the Deed will show as a matter of public record that the Purchaser is the new owner of the property.
The Seller has the right to borrow against his or her remaining equity in the property sold. In other words, if the Seller owned a $50,000 property free and clear and then sold it to the Purchaser who made a $10,000 down payment, the Seller initially has the right to collect $40,000 (his or her remaining equity in the property) and he or she may borrow money by allowing a lender to put a senior lien on the property (ahead of the Purchaser's interest in the property) for up to $40,000. However, since the Seller must be in a position at all times to convey the Deed to the property when the Purchaser makes the final payment on the contract, the Seller can never owe someone else more than he or she is owed by the Purchaser.
To protect the Purchaser from any debts that the Seller may have against the property, the Seller must provide notice of any such mortgage and its terms in a certified letter to the Purchaser. The Purchaser also has the right to make the payments for the Seller on any debt for which the Seller is in default. Any such payment made by the Purchaser, of course, will be deducted from the monthly payment owed by the Purchaser to the Seller.
In short, the Seller must never owe on the property more than he or she is owed.
A Seller almost always has the right to freely assign his or her interest in the land contract. (An exception might be if the Seller is still making payments on the property himself or herself and the contract governing that purchase restricts the Seller's ability to assign.)
The Purchaser, however, often has the right to assign his or her interest in the contract only after obtaining written permission from the Seller. This protection for the Seller exists because the Seller may have sold the property to the Purchaser on the strength of the Purchaser's character, time on the job, or credit rating, among other things. When this Purchaser then proposes that a new person begin to be primarily responsible for making payments to the Seller, the Seller has the right to know and approve this in writing.
Such an assignment by the Purchaser to a new purchaser usually does not release the original Purchaser from obligations to perform under the contract if the new purchaser fails to live up to the terms of the original land contract.
If the Purchaser fails to perform any significant part of the contract, the Seller may have the right, after notifying the Purchaser in writing of the exact nature of the default, to treat all payments already made on the contract as mere rental payments made by the Purchaser. Some states have very specific guidelines regarding default, so be sure to check with your legal professional. If the default continues, the Seller has the right to declare the remaining balance due and payable, and if the default is not then cleared up or the contract is not paid in full, the Seller can begin steps to regain possession of the property. Improvements made to the property by the Purchaser then become the Seller's property.
Defaults by the Purchaser may include failure to make timely payments, failure to properly maintain the property, failure to adequately insure the property, or failure to pay taxes on the property as they become due.
All contracts end with a series of miscellaneous provisions regarding where payments and notices should be mailed, which state laws govern the contract, and so forth. The provisions in a standard pre-printed land contract are not nearly as important as any typed provisions at the end of the contract. Read and enforce these typed provisions carefully.
To have a contract that can be recorded in the county records where the property is located, be sure to have the contract notarized by a licensed notary. The fee, if any, is usually nominal.
Also, have two witnesses available to observe the signing of the contract.
A land contract signed without witnesses or a notary should be fixed with the help of a local attorney or title company. This will enable the contract to be recorded for the safety and benefit of all parties.
Your RE/MAX Valley Real Estate Professional cannot write a land contract because he/she is not a licensed attorney in the state of Ohio. However, they are well versed on the "ins" and "outs" of such contracts, and can help you decide whether this type of financing is right for you, and if so, recommend several attorneys from which to choose to write a contract for you.