How a Land Contract Differs from a Mortgage

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A land contract and a mortgage have a number of similarities. For example, you can use either option to purchase a home Both loans must be repaid on a monthly basis.

Understanding the Differences 

A land contract is a legal agreement between a buyer and a seller. Rather than a traditional mortgage scenario with a bank, the seller becomes the lender. The buyer and seller agree on a price for the home then negotiate terms and a payment schedule. 

In many cases, these repayment terms follow a schedule of monthly payments much like a mortgage. However, a balloon payment for the remaining balance is often due within three to five years. At that time, you would then obtain a traditional mortgage to fund the remainder that's due. 

Land Contract Risks

While it can seem like a land contract would be an ideal way to secure a home, it does involve risks you need to know about. A land contract can be a way for you to close on a home if you aren't able to qualify for a mortgage that covers the full cost right away. The three to five years that a typical land contract lasts can give you time to improve your credit and increase your financial soundness. 

Before you agree to a land contract, though, be aware that the property is not yours until you make the final (balloon) payment. This means that if you make any improvements to the property during that time, you could potentially be out of your investment. You are also not building up any equity in the home during the time that the land contract is in effect. 

At any point during the land contract, your position as the buyer could be compromised. For example, the seller is the legal owner of the property until the contract has been fully paid. If they experience financial problems and lose the property, you would have no claim to it and would forfeit your payments. 

As the buyer, you are obligated to meet your payment agreement. If you don't do so at any time during a land contract, the deal ends. The property stays with the seller and you are out the money you've invested. 

Advantages of a Mortgage

With a mortgage, you must pay property taxes and honor your obligations to the lender. As long as you do so -- and avoid liens -- you have legal recognition as the property owner. 

A land contract can seem like an attractive alternative if you don't think you qualify for a traditional mortgage. Before agreeing to one, though, be sure you understand the pitfalls that could be involved.