Land Contracts: Shaky Ground or Solid as a Rock? Part II

by Andrea S. Alford, Deputy Executive Director

In our first installment of this series, we discussed how buyers should approach a land contract. Now we will examine the implications of land contracts for sellers. As a critical reminder, the Commission urges buyers and sellers alike to engage the services of a qualified Arkansas real estate attorney in navigating these very complex instruments.

One of the most important considerations for any seller in this situation is whether or not their existing mortgage has a “due-on-sale” clause that could be triggered by a land contract. Sellers are sometimes under the impression that a land contract does not qualify as a true sale because fee simple title does not transfer until the buyer fulfills all financial obligations under the contract. However, the buyer in a land contract does obtain “equitable title”, which qualifies as a sale under a due-on-sale clause. Most mortgages contain a due-on-sale clause and are not considered assumable without the lender’s consent. In simplest terms, a seller with an existing mortgage could be required to immediately pay the full remaining balance of that mortgage if he sells the property using a land contract.

Next, sellers in Arkansas should be aware of the maximum constitutionally allowed interest rate so as not to run afoul of Arkansas Usury Law by charging a rate of interest that is too high. By the same token, sellers should also consider the potential tax implications arising from charging too little interest or none at all, as one might if the land contract is negotiated between family members.

Sellers often mistakenly assume they have the ability to immediately evict a buyer who fails to make payments, or defaults, on the land contract just as they would a tenant under a rental agreement. This may or may not be true, based on the down payment made, the number of installment payments made and any improvements made to the property by the buyer. Arkansas law follows the ancient maxim that “equity abhors foreclosure”. In other words, a buyer who has a good deal of skin in the game may not be subject to eviction for default and may instead have protections under law that require the seller to seek actual foreclosure, either judicially or non-judicially. To that end, sellers should be aware of what is required under Arkansas law should they wish to avail themselves of the statutory (non-judicial) foreclosure remedy.

Just as some buyers may enter into land contracts when they cannot secure traditional financing, occasionally sellers agree to land contracts as an alternative to a typical real estate sale due to unfavorable market conditions or an urgent need to sell precipitated by a change in the seller’s income, employment or living situation. In these situations, sellers should exercise great caution, both in evaluating prospective buyers and in honestly assessing their own circumstances and risk tolerance. In plainest terms, if a seller cannot afford to maintain the existing mortgage payments should the buyer default on the land contract, the seller may need to consider other options.

A final and critical consideration for sellers in land contracts is that of property condition, alterations and repairs. Although legal title does not transfer in a land contract as it does in a typical real estate transaction, the nature of the agreement and the physical transfer of the property lend themselves to the buyer’s belief that they own the property and can do with it as they please. As such, the buyer may make alterations to the property to suit their needs or desires. In some cases, buyers may simultaneously view the seller as a landlord who is responsible for funding said alterations as well as any repairs the property may need over time.

Clearly, land contracts present multiple challenges to buyers and sellers alike. So if land contracts are so fraught with peril for everyone involved, why would anyone ever want to agree to one? The answer is simple. Sometimes it’s the best option. Sometimes it’s a buyer’s best shot at owning a home. Sometimes it’s a seller’s best shot at finding a buyer. And sometimes land contracts go off without a hitch from start to finish, and everyone benefits in the end.

Whatever the case may be, the Real Estate Commission strongly encourages buyers, sellers and real estate agents and brokers to involve a qualified Arkansas real estate attorney to assist in these matters. Real estate agents and brokers can find guidance specific to their involvement here.

This article was originally published in the Arkansas REALTORS® Association's House to House column in the Arkansas Democrat-Gazette.