Experts caution that private real estate deals may give low-income homebuyers a false sense of hope.
Why Land Contracts Are a Risky Choice for Homebuyers
Many aspiring homeowners see a land contract as the answer to their prayers, but mortgage experts and lawyers say they almost always result in financial calamity.
“Land contracts and leases with option to buy are both costly and destructive detours that diminish the likelihood that consumers entering these contracts will ever own a home,” said Sarah B. Mancini, co-director of advocacy for the National Consumer Law Center.
“We estimate that more than half of these transactions fail. Indeed, we believe that these transactions are designed to fail.”
Ms. Mancini testified before the Senate Banking Committee’s Subcommittee on Housing, Transportation, and Community Development on July 11.
She, and other witnesses, said land contracts, contract for deed and lease with option to own schemes disproportionately target low-income minority home buyers who typically can’t qualify for traditional mortgages.
A homeowner talks to a Wells Fargo representative during a “Save the Dream” event in Los Angeles to help homeowners restructure their mortgages to avoid foreclosure, in September 2010. (Kevork Djansezian/Getty Images)
The plans are arrangements between buyers and sellers in which the parties agree on a selling price and payment plan. Many states don’t require the deals to be recorded with the court.
In addition, regulations differ from state to state, and many buyers know little about real estate transactions. So, they don’t take advantage of the law because they don’t realize they may have legal rights.
The buyer takes on the responsibilities of a homeowner or landlord but has none of the protections afforded by law in a more traditional mortgage. In the land contract, the buyer is responsible for all repairs, taxes, liens, and other expenses, but the seller retains ownership.
In many cases, buyers get uninhabitable homes. They may make thousands of dollars worth of improvements only to be evicted when they miss a payment or can’t make an agreed-upon balloon payment.
In addition, the deals generally don’t require property inspections, title searches, or other requirements that go along with getting a mortgage from a financial institution.
Ms. Mancini said this creates a minefield of possible hazards.
Land contracts often don’t require home inspections which can put buyers at a disadvantage. A proper home inspection by an individual trained in inspecting a home has several advantages over other options. (PPC Photography Cologne/Shutterstock)
“No one should purchase a home without having a lawyer do a title search to make sure the person selling it actually has good title,” Ms. Mancini said.
The deals often come with high-interest rates, inflated asking prices, and non-refundable deposits and fees.
Sen. Tina Smith (D-Minn.) chairs the subcommittee. She said the practice began in the 1960s and reappeared after the financial crisis of 2008 when the housing market was flooded with foreclosed properties.
“Typically, they’re targeting black and brown and immigrant communities, poor communities, groups that have long suffered from housing discrimination,” she said.
Smith pointed out that a traditional mortgage or rental contract requires specific steps to be taken if the buyer is to be evicted. In those instances, the buyer is liable for unpaid debt and fees but can keep any equity built up during the contract.
In a land contract, the buyer can be evicted for missing a single payment. An Orange County Sheriff eviction notice in Laguna Hills, Calif., on March 28, 2008. (David McNew/Getty Images)
It is different in a land contract; the buyer can be evicted for a single missed payment and loses all of their money.
“If they default on those payments there is no requirement in Minnesota law they get any of their money,” said Elizabeth Goodell of the Mid-Minnesota Legal Aid.
Many of her clients have been taken in by unscrupulous contracts for deed businesses. She said that in Minnesota, the land contract is called a contract for deed.
The buyers often have never bought a home, so they don’t understand the process. Often, they speak little or no English or feel they have nowhere else to turn due to bad credit or a lack of credit.
In a lease with an option-to-buy plan, the buyer leases the property for a set time and pays a fee for the option to buy the property when the lease runs out. If the buyer doesn’t execute the purchase option, they lose the fee and can be evicted.
Many Buyers Should Rent Instead
“Contract for deed buyers most frequently come to our attention … when they are being evicted,” Ms. Goodell said.
She added that many clients would be good candidates for affordable rental units. This also means they would be good prospects for small mortgages. However, many lenders don’t want to handle mortgages lower than $125,000 because they typically don’t realize a good
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