Recorded mortgage or land contract: which is the better instrument to hold as capital provider

Question

For anyone structuring seller financing, there are two common shapes and they are not the same asset to hold. First shape. The seller deeds the property to the buyer at closing, and the buyer signs a promissory note plus a mortgage or deed of trust that gets recorded against the property. The buyer owns the house. The seller holds a lien. If the buyer stops paying, the lien is enforced through whatever process the state uses, judicial in some states, nonjudicial in others, with very different timelines and costs. Second shape. A land contract, also called a contract for deed or installment land contract depending on the jurisdiction. The seller keeps legal title while the buyer takes possession and pays over time, and the deed transfers once the balance is paid. Remedies here are governed by state statute and case law, and several states have consumer protection rules that treat a land contract buyer with substantial equity closer to a mortgagor, so the fast forfeiture some expect may not actually be available. Whether that holds in a given state is a question for local counsel. From a capital markets view, the recorded mortgage is the standard, plain, recordable instrument the note market is built around, which matters if the note may ever be sold. The land contract tends to get used on low balance deals where the cost of a full foreclosure would swallow the equity. Reasonable practitioners land on different sides of which is the stronger position to hold, and the right answer often depends more on the state and the deal size than on a universal preference.

angela_burke · Answer

Land contracts that come back to sellers often take longer to unwind than expected. It's common for a buyer to have been in for several years with real money already invested, which turns what looks like a quick forfeiture into a drawn out negotiation instead. Whatever the statute says on paper, the practical timeline tends to run months, not weeks.

mitchell_ray4 · Answer

Question from the trades side. If the buyer on a land contract reroofs the house and then defaults, who owns the roof? Do they get paid for it or does that just become the seller's improvement?

ryanmck27 · Answer

@mitchell_ray4 the general answer is that improvements go with the real estate, so if the contract terminates the improvement stays. What the buyer can recover for it depends on state law and on the contract itself, and the licensing material I'm working through says almost nothing useful about it, which tells you it's a lawyer conversation.

Disclosure requirements around installment sales also differ by state, so don't assume the same paperwork works two states over.

omar_haddad · Answer

I sold a beat up two bedroom on a land contract once and the buyer gutted the only bathroom in month five, then ran out of money and stopped paying. So I got the house back with no bathroom, which is worse than the house I sold! Scope creep, except it wasn't even my scope.

If I did it again I'd want a clause about alterations over some dollar amount needing written consent, and I'd want to know what my remedy actually costs before I signed anything.

laurenkim53 · Answer

In many rural markets, price points make this decision for people. On a $38,000 house with $3,000 down, a judicial foreclosure can cost a meaningful fraction of the whole balance, and sellers use land contracts because the math on the standard route doesn't work. Whether that's the better instrument or just the affordable one is a different argument.

aaron_fitz10 · Answer

Which of the two is actually easier to sell to a note buyer later is the part that would decide it. That question matters most when it's not yet clear whether the holder wants to keep it or move it.

chriswalton8 · Answer

@aaron_fitz10 buyers on the note market generally want a promissory note secured by a recorded first mortgage or deed of trust, with a title policy and a clean legal description. Land contracts do trade, and they trade at wider discounts, and some buyers won't touch them at all in states where the remedy is slow or unsettled. So if liquidity matters, the first shape narrows the discount. If the note is never being sold, @laurenkim53's cost argument is the one that bites.

nataliehsu · Answer

What strikes me reading this is that the choice is mostly about what happens when things go wrong, and everyone underwrites the good case. @omarhaddad lost a bathroom, @angelaburke spent months on two files, and none of that shows up in the yield you calculate at closing.

Recorded mortgage or land contract: which is the better instrument to hold as capital provider

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