Think of an installment land contract as a "mortgage within a mortgage." After agreeing on a purchase price, the buyer pays the seller a monthly amount that at least equals the current mortgage payment. If possible, the seller will try to include the property tax and insurance escrow as part of the buyer's monthly payment. The land contract will then operate like a mortgage, with the buyer paying the seller instead of a lender. The seller does not transfer the deed or ownership until the terms of the land contract are complete and the recorded bank mortgage is paid off.
Some U.S. states restrict the use of installment land contracts, but in most cases, unless the deed is transferred early to the buyer, these agreements are legal. Should the homeowner/seller have an owner-occupied mortgage, the lender may want to modify the terms of the loan if it learns of the agreement. For example, once the homeowner ceases to occupy the home, the real estate becomes investment property, which normally carries a higher mortgage interest rate. In some cases, the mortgage lender has the right to consider the home loan in default and demand payment in full immediately.
Most land contracts require some form of down payment from the buyer. The seller can simply keep records that show that the down payment was subtracted from the agreed upon selling price. Since most buyers agreeing to land contracts have insufficient down payment funds to qualify for a bank mortgage, sellers should understand that few people will have 10 to 20 percent of the purchase price to offer.
Both buyer and seller should have an attorney review the installment land agreement to avoid potential future legal problems with contract terms, language or fairness. The seller's attorney can collect and escrow the down payment and manage a closing to seal the deal. Using a lawyer to advise, consent and close the transaction further legitimizes treating the agreement as a mortgage loan. An installment land contract is a type of seller financing.
Similar to a Balloon Mortgage
Most installment land contracts include a date to complete the purchase much shorter than the term of the recorded bank mortgage on the property. This reality mirrors a true balloon mortgage loan. Typically, balloon mortgages require monthly payments calculated to pay off the loan in 15 or 30 years. However, a pay-in-full date is much shorter, for example five to10 years, resulting in a final payment thousands of dollars higher than the 15- or 30-year monthly payment. Hence, the aptly descriptive name "balloon mortgage." When the buyer makes the final payment that pays off the outstanding mortgage, the deed and title to the property transfer to the buyer.