Lease Option vs Land Contracts

Often times, lease option sellers fail to see what could be a more beneficial sales technique for their particular deal: a land contract sale. There are times when a land contract is actually a more beneficial sales vehicle than selling using a lease option contract. In certain cases, a land contract can actually be used to speed up the process of cashing a home out.

The reason why some sellers prefer to sell a home using a lease option is because the seller stays in an ownership position until the lessee-buyer pays the seller off (usually with a mortgage). If a lessee-buyer stops paying their monthly obligation for whatever reason, the seller can just evict them because the lessee-buyer is just a tenant. With a land contract, the seller is actually transferring ownership of the home before being paid off in full by the buyer. The sale gets recorded at the registrar of deeds office in the county where the property is located in and the sale becomes public record. In order to protect the seller’s financial interest, a mortgage is drawn up and recorded as a lien (a stake in) against the property, which gets discharged when the mortgage is paid.

So why would a seller want to sell by means of a land contract? Because the face value of the land contract can be discounted by the seller and quickly sold to a note buyer or other mortgage lender who elects to receive payments long term on the note (mortgage). For example, a seller decides to sell his home on land contract, and creates a mortgage with a buyer at 7.5% interest over 30 years for $200,000. The buyer puts $10,000 down and moves in. Shortly after the land contract gets recorded, the seller gets antsy and wants to cash the land contract out to receive a lump sum of cash rather than the monthly payments as stipulated in the mortgage note. The seller discounts the mortgage down to $160,000 (to create attractive terms) and sells it on the open market to a note buyer. In this scenario, the seller was able to access $160,000 by selling his mortgage note. This cannot realistically be done with a lease option deal. The drawback to selling the mortgage note however, is that the seller had to kiss $40,000 in note face value away; not to mention the nearly 30 years of monthly payments which would have netted hundreds of thousands of dollars in interest to the seller of the home.

Land contract sellers should have their buyers sign an addendum to the land contract stating that if they fail to pay the seller-held mortgage, then the seller can take possession of the house back within 90 days. Commonly called a deed in lieu of foreclosure, this addendum keeps sellers from having to foreclose on buyers which can take up to one year in some states and is the major drawback to selling a home on land contract.

Perhaps the best part of a land contract is that the interrelated “seller financing” aspect creates excellent financial options for both buyer and seller. Generally, it is harder for a buyer to obtain purchase financing than it is for an established property owner to perform a rate/term refinance. When a seller acts as a bank, as in the case of a land contract sale, by creating a formal mortgage and then recording it against a property, the buyer (who is now the owner of the subject property) can then go to a bank and apply for a rate/term refinance rather than applying for a purchase loan. This means the buyer does not have to show a down payment; the equity in the property is the down payment! In other words, the equity-bearing land contract deal has a far better chance to close than a similar lease option deal requiring a buyer’s down payment as stipulated by the buyer’s qualifying lender. In order to execute a rate term refinance for the buyer, the seller must do several things:

Randy Bailiff
Dean Graziosi Real Estate Investment and Life Coach