The Lowdown on Land Contracts

A land contract (sometimes known as a “land sales contract” or “contract for deed”) is becoming an increasingly popular way to sell a home. The biggest advantage to a land contract is that the buyer does not need to meet the credit standards of a bank in order to receive a loan. Depending on the deal structuring, it can also mean that a buyer does not need a substantial cash down payment. A land contract is ideal for individuals with a steady income and the ability to make monthly payments, but lacking the available cash and/or credit score to get a traditional mortgage.

A land contract can also be an advantageous to the seller, as they can sell the property in question on their own terms without the need for bank approval and charge an interest rate which reflects the buyer’s lack of cash and/or credit. Land contracts can be great investments for sellers if the property is sold to the right individual.

What happens when a land contract goes bad?

In a land contract, the seller takes the position of the bank. In that position, they are also responsible for collecting payments and taking back the property in the event the buyer breaches the contract.  Many believe that a seller can simply evict the buyer in a small claims court and retake the property, much like a landlord would if a tenant stopped paying rent. This simply isn’t true. In the pivotal case of Skendzel v. Marshall, 301 N.E. 641 (Ind. 1973), the Indiana Supreme Court held that a conditional land sales contract is a secured transaction and once a buyer obtains a substantial interest in the real estate, the seller must accelerate the debt and go through the process of foreclosure, rather than forfeiture. A buyer may still file an action in the proper court with the proper pleadings requesting forfeiture, but the courts will only grant that request if the buyer has not obtained a substantial interest, has abandoned the property, or the buyer receives a default judgment.

What is a substantial interest?

In response to Skendzel v. Marshall, attorneys began defining “substantial interest” in the land contract. This approach was rejected by the Indiana Courts, who decided that they, not the buyer or seller, will decide what constitutes a substantial interest in the real estate. This leaves great judicial discretion in each case for determining whether a buyer has obtained substantial interest.

Forfeiture vs. Foreclosure

In most cases a buyer through their attorney will file an action with the proper court requesting forfeiture with foreclosure as the alternative. The advantage to forfeiture is that the seller can take back the property quickly. The disadvantage is that the buyer does not have any further legal recourse against the buyer for non-payment.

The foreclosure process in Indiana is a bit convoluted. The seller must first give the buyer notice of the breach of contract. Next, they must file a complaint with the court and accelerate the entire balance of the debt. After acceleration, the buyer has the opportunity to redeem the property if they can pay off the balance. This is rarely the case and provides the buyer with additional time in which they possess the real estate without making payments. If the buyer cannot pay the balance during the redemption period, then the seller receives a judgment and the property is sold at a sheriff’s sale.

In a sheriff’s sale the seller and others bid on the property in question. The seller can bid up to the amount of the judgment they receive (the amount owed by the buyer). If the seller bids less than the entire amount owed and that bid wins, then the seller will receive a deficiency judgment against the former buyer. The advantage to a foreclosure is that the seller can retake the property and still collect money from the former buyer.

Conclusion

If you have ever purchased a home, you know the great lengths a bank goes to in order to secure its interest in the real estate when a buyer receives a mortgage. In a land contract, a seller essentially steps into the bank’s shoes so it wise to seek an attorney’s advice in drafting a land contract and taking back a property that is subject to a land contract. If you have any questions about the foregoing or would like to discuss land contracts in further detail, please feel free to contact me.