Land contracts are speedy, simple, and less costly
Land contracts are particularly attractive to beginning farmers who ultimately want permanent tenure in land but don’t have a lot of capital, and for whatever reason cannot qualify for an institutional loan. Land contracts are often much faster, easier, and less costly to finalize than land purchase transactions involving banks and mortgages. These are the essential benefits of land contracts. They don’t require tons of upfront costs, including a large down payment, origination fees for a mortgage, or high closing costs. They basically take out the middle man—the institutional bank—and let the buyer and seller negotiate the deal themselves on their own timeframe and their own terms.
The buyer risks losing everything on default
However, land contracts may carry significant risks for the buyer. The biggest risk of all is that land contracts typically include a forfeiture clause, which allows the seller to cancel the contract if the buyer defaults on the contract, which could include making a single late payment. This is a harsh consequence. If the buyer defaults and the seller terminates the contract, not only would the farmer-buyer lose her possession of the farmland, she would also lose all the previous payments she made. Imagine all that hard work and money spent enhancing the soil, maintaining farm buildings, building fences, learning the subtle nuances of the land in anticipation of owning it outright—all abruptly lost because of one late payment!
Oftentimes courts will step in and give the buyer time to cure the default, which we’ll discuss more next, but the time period for correction can be as short as 30 days. Additionally, many states require the buyer to come up with the entire remaining balance owed on the land contract, not just the amount of the late payment, to reinstate her right to own the land.
The buyer may face challenges in coming up with the balloon payment
Another key risk is the balloon payment that some land contracts require. Many people have lost their homes and land because they weren’t able to come up with this balloon payment. Five or more years may seem like a far off time to make such a payment, but it can come up surprisingly quickly. If the farm business doesn’t turn a profit or doesn’t go as well as planned, the farmer-buyer could have a hard time coming up with the money. If this is the case, the farmer-buyer will pretty much be back to square one—looking for a loan from an institutional lender to cover the balloon payment and having to “qualify” and pay added costs such as origination fees to secure the financing. And if the farmer-buyer doesn’t make the balloon payment at the time specified in the land contract, it would be considered a default, and she risks losing the property and all the previous payments made.
Can I take out a mortgage to pay my balloon payment?
An increasing number of states are allowing a buyer to take out a mortgage on property to be owned under a land contract; however, the actual method in which the buyer takes a mortgage varies state by state. Farmers should be sure to check with specific state laws before taking out a mortgage on farmland subject to a land contract.
Of note, some states treat a land contract as a normal mortgage, which is explained in the next section. In these states, when a buyer takes out a mortgage on land subject to a land contract, the land contract is treated as the first mortgage and the mortgage that the buyer undertakes is treated as a second mortgage. Should the buyer default on either mortgage, the seller could foreclose on the property and the bank which held the second mortgage would be treated as a junior creditor, as the seller would have priority. This may make it challenging for a farmer-buyer to secure a mortgage to pay the balloon payment as institutional lenders prefer not to be second in line as a junior creditor and will most likely increase the interest rates or require other costs or restrictions in such a case. Keep this in mind when negotiating the timeframe of your land contract and be honest with yourself about the realities of making a future balloon payment.
The buyer risks losing out on any improvements made to the land
One other risk is that farmers often want to make improvements to the land right away, such as installing fences, renovating out buildings, or constructing a new packing shed. Unless the land contract adequately addresses what happens to these improvements upon a potential default, the farmer-buyer risks losing all the costs incurred. Farmer-buyers who intend to make changes or improvements to the property before making all the required installment payments under the land contract should pay careful attention and try to negotiate favorable terms for how these improvements are handled. For example, the land contract could specify that the seller compensates the buyer for the improvements or it could establish a formula for determining how much the seller owes the buyer for the improvements upon default. Either way, farmers need to know the risks involved.