With more land contracts in use recently, a land contract refresher is in order!
A land contract may be used when the seller finances the buyer’s purchase of the property. The land contract buyer pays the seller in installments and receives a deed when all payments have been made. As an alternative to the seller giving a deed and taking back a mortgage, the land contract seller reserves title to the property as security. The parties may use a land contract to negotiate a sale when conventional financing is not available to the buyer or is not feasible.
1. What is a land contract?
A land contract is a form of seller financing. It is a written agreement by which a seller, or “vendor,” promises to convey the seller’s property to the purchaser, or “vendee,” if the vendee makes payments under an installment payment plan.
The land contract purchaser takes possession of the real estate and promises to make installment payments of principal and interest, typically on a monthly basis, until the contract is paid in full. Often there is a large payment due at the end of the term and the purchaser may need to secure traditional financing or find another source to make the final balloon payment.
2. What is the difference between legal title and equitable title?
A common misconception among parties to land contracts is that the “sale” has not yet occurred because a deed has not yet been given. Actually, the sale of the property occurs when the land contract is executed and possession is delivered to the buyer.
During the term of the contract, the purchaser has “equitable title” to the property and takes physical possession. The purchaser becomes, for all practical purposes, the owner of the real estate.
The vendor has legal title to the property until the contract is paid in full and then must convey the property by deed to the purchaser. Under Wisconsin law, the seller has conveyed his ownership interest in the property and retains “bare legal title” as the seller’s security interest in the property. The vendor retains legal title, but that title is really only held as security for payment.
3. What are some advantages for the seller?
A land contract can attract buyers who face various obstacles in qualifying for traditional mortgage loan financing. The seller may also be able to attract a broader range of potential buyers by offering land contract financing. Enforcement of a land contract is somewhat easier than enforcement of a mortgage, but the seller assumes the risk that he or she will have to retake the property and resell it.
4. What are some advantages for the buyer?
A land contract allows a buyer who is not able to secure traditional financing to purchase real estate. The buyer has time to work on any credit issues he may have, including lowering his debt-to-income ratio, and to save for the down payment on a traditional loan used to make the balloon payment on the land contract. Land contracts are also used when the buyer is related to the seller.
5. Is there a problem under the SAFE Act for brokers drafting offers calling for land contracts?
Changes to the Secure and Fair Enforcement Mortgage Licensing Act of 2008 (SAFE Act) were made in Wis. Stat. §§ 224.71-224.77 to remove many of the prior seller financing limitations on agents drafting seller financing offers as well as sellers providing seller financing when selling their own properties. There is now an exemption for sellers not regularly engaged in the business of a loan originator who occasionally offer seller financing on five or fewer transactions per calendar year. The same is true for a broker writing offers on five or fewer transactions where seller financing is offered.
Another new exemption in Wis. Stat. § 224.71(13) is intended to exempt real estate brokers who are engaged solely in the practice of real estate brokerage and use state-approved forms. Brokers will not be required to register as mortgage loan originators if they negotiate offers with seller financing as long as they use the forms approved under Wis. Admin. Code § REEB 16.03. That rule approves real estate licensees to use the forms such as the WB forms approved by the REEB; forms prepared and approved by the state bar of Wisconsin including deeds, mortgages and land contracts; out-of-state forms for out-of-state real estate and business transactions; and forms prepared by government agencies such as the FHA or VA.
6. Are there approved forms for a land contract?
Yes, the State Bar of Wisconsin has a standardized form of land contract known as a “Form 11 Land Contract.”
7. Can all licensees draft a land contract?
No, only those licensed as a Wisconsin real estate broker may use the State Bar forms. Wis. Admin. Code § REEB 16.03(1)(a) allows brokers to use forms prepared and approved by the State Bar of Wisconsin for deeds, mortgages, mortgage notes, land contracts, release of mortgage, satisfaction of mortgage, assignment of mortgage and assignment of land contract. That same privilege does not extend to those with a real estate salesperson’s license.
Brokers, however, should be cautious about inadvertently providing legal advice to parties. As always, if the parties have questions about what is best for their personal financial, tax or legal situation, they should be urged to consult with their financial, tax and legal advisors.
8. What is the best way to draft an offer for a land contract?
In the typical Wisconsin residential land contract transaction, the owner of the property first enters into an offer to purchase with the buyer contingent on the seller agreeing to provide land contract financing. The key when drafting the offer to purchase for a land contract transaction is to have the parties agree on all of the terms and conditions that will be needed to complete the land contract document at closing. Land contract terms and conditions may be addressed in the Additional Provisions sections of the offer forms or in addenda.
The offer might include a land contract rider specifying the terms of a land contract. The WRA Land Contract Rider, which is WRA form number WRA-LCR, spells out the terms the buyer wants in the land contract and may raise additional details the parties have not yet considered. An offer for a land contract may also be achieved by completing a Form 11 Land Contract, except for signatures, and using it as an addendum to the offer.
9. What is a “due on sale” clause?
If the land contract seller has a mortgage on the property being sold and does not obtain the consent of the mortgage holder regarding the land contract sale, the “due on sale” clause in the mortgage may require the land contract seller to pay the total remaining balance due on the mortgage as soon as equitable title is transferred. Therefore, it is crucial for the seller to consult with the mortgage holder and obtain written consent to the land contract sale. Sellers with questions about this should be referred to their attorneys for legal advice!
10. Is a land contract recorded with the register of deeds?
The land contract is recorded with the register of deeds, giving notice to all of the vendee’s interest in the real estate and the vendor’s obligation to convey the real estate upon full payment. The transfer fee is due at the time the land contract is recorded, along with a transfer return. When the buyer conveys the real estate by deed, no additional transfer fee is collected, although another transfer return will need to be filed.
11. Do land contracts affect the payment of commission?
Because the seller in a land contract transaction is not receiving the full sales price upon execution of the land contract, there can be issues with commissions that may need to be worked out with the seller. The listing contract states, for instance, on lines 64-65 of the WB-3 Vacant Land Listing Contract, “Once earned, the Firm’s commission is due and payable in full at the earlier of closing or the date set for closing, even if the transaction does not close, unless otherwise agreed in writing.” The firm’s commission is earned if the seller “sells or accepts an offer which creates an enforceable contract for the sale of all or any part of the Property” at line 53 or if “a transaction occurs which causes an effective change in ownership or control of all or any part of the Property” at line 56. The closing for a land contract conveys the equitable ownership interest in the property, hopefully creates an enforceable contract for the sale of the property, and thus triggers the seller’s commission obligation. The execution and recording of a land contract also represents an effective change in ownership or control because the land contract buyer is treated as the owner while the seller is treated as the secured party.
If the buyer’s down payment under the land contract is not enough to pay the listing firm’s commission, the sellers and the listing firm can look for other solutions. For example, the sellers may offer to pay part of the commission after the terms of the land contract are fulfilled. If the listing firm agrees to the sellers’ proposal, this should be documented in an amendment to the listing contract. Sellers might also give the firm a promissory note for the remaining commission due. Other arrangements may also be made as long as the sellers and the listing firm agree, and they commit their agreement to writing.
12. How is a land contract enforced?
The parties to a land contract can negotiate their own remedy to end the land contract relationship. This typically will involve the buyer quitclaiming the property back to the seller. The seller first should confer with legal counsel to examine any liens that may have attached to the buyer’s interest in the property — it must be determined whether the liens will survive and continue to apply to the property if the buyer deeds it back to the seller. If the buyer has significant liens, the seller may choose to foreclose in order to remove the “hitchhiker” liens from title.
The seller may declare the land contract to be at an end and file a quiet title action to remove the land contract as a cloud on the seller’s title to the property. This remedy generally is only used if the buyer’s equitable interest in the property is insignificant.
The seller can sue the buyer for the money owed and get a money judgment. The acceleration clause in the Wisconsin State Bar Form No. 11 Land Contract makes it possible for the seller to declare the entire outstanding balance to be immediately due and sue for the balance if the buyer defaults on just one installment payment. This remedy allows the seller to quickly obtain a money judgment against the buyer.
The seller also can sue for foreclosure by sale, usually called “specific performance.” This is similar to a mortgage foreclosure. The court establishes the redemption period in the foreclosure judgment. The court has a certain amount of discretion in fixing the redemption period, which may be as short as two months. If the buyer does not pay the balance, the sheriff sells the property at public sale. If the property does not bring in as much as the buyer owes, there may be a deficiency judgment against the buyer for the unpaid balance.
It may be more likely that a land contract seller will ask for a strict foreclosure. The seller who chooses this remedy has elected to rescind the contract, so he or she cannot get a deficiency judgment for the unpaid balance due on the contract. The seller gets his or her property back and keeps payments already made. There is no sheriff’s sale. Costs may be less than those for a mortgage foreclosure, and the time required to complete the strict foreclosure is usually less than for mortgage foreclosure.
Debbi Conrad is Senior Attorney and Director of Legal Affairs for the WRA.
Resources
March 2014 Legal Update, “Legislative Update 2014,” at www.wra.org/LU1403.
“SAFE At Last: New law removes mortgage loan originator licensing requirements for sellers and REALTORS®” in the May 2014 Wisconsin Real Estate Magazine at www.wra.org/WREM/May14/Safe.
January 2001 Legal Update, “Land Contract Financing,” at www.wra.org/LU0101.
July 2008 Legal Update, “Using Land Contracts and Leases with Options,” at www.wra.org/LU0807.