LAND CONTRACT vs LEASE PURCHASE/OPTION

Reprinted with permission
Written by Terrance Monnie, Attorney

Agents and Clients,

The purpose of this memo is to discuss three very commonly utilized methods of dealing with the sale and purchase of real property.


Lease-Option: As the title implies, a property owner agrees to lease property to a tenant and that the tenant has the option (but is not required to exercise it) to purchase the property either during the lease term or at the end of the term. Ohio's Landlord Tenant Law (ORC 5321) applies. Most lease-options provide that the tenant may exercise the option only if they are not in default of the terms of the lease. This format favors the tenant, who may or may not exercise the option and doesn't give the owner much help other than the rent received, not does it achieve the goal of selling the property.

Lease-Purchase: Like the lease-option, the owner leases the property to the tenant; however, the tenant is obligated to purchase the property at the price and on the terms specified in the lease-purchase agreement. If the tenant defaults, the owner has various remedies ranging from eviction to forgiveness. Note that with both the lease-option and the lease-purchase formats, landlord-tenant laws apply. While both these methods have their merits, they lack overriding benefits of a land installment contract.

Land Installment: Contract: Land installment contracts are a creature of statute in that what is and is not land contract and its requirements are set forth in great detail in ORC 5313. What follows is a summary of the most important features:

• As the name implies, land or real estate property (normally 1-4 family residential) is being sold in installments for periods in excess of one year.
• Legal title remains vested in the seller until such time as the final payment is made on the land installment contract. This gives the seller the assurance that he has more control during this period and the buyer has ll other rights and obligations of ownership (benefits and burdens), including, but not limited to, maintenance, insurance, etc.
• Most sellers have an existing mortgage on the property being sold and most every mortgage in existence today for residential property is the standard FNMA/FHLMC )Fannie Mae/Freddie Mac) mortgage form. These mortgages have a "due on sale" provision which specifies that the owner/borrower may not covey any "beneficial ownership interest" in the mortgaged property without the prior written consent of the lender. This provision has a very broad range and almost every conveyance, except between husband and wife will normally trigger the "due on sale" clause, giving the lender the right to call the loan due (acceleration) in the event of such a sale (including a land installment contract). agents need to make this disclosure but I recommend that you retain legal counsel to assume this responsibility to avoid being charged with unlawful practice of law. From my perspective and experience, while the disclosure must be made, I tell my clients that their first course of action is to notify the lender of their intentions and get written approval from an authorized officer representing that lender as a precondition to avoid future problems and the triggering of the "due on sale clause."    
• What if the buyer defaults? Under the statute, land contract buyers who have either (1) paid more than 20% of the total purchase price or (2) have paid on the land installment contract for a period in excess of five years cannot be evicted but the land contract must be foreclosed like a standard mortgage. This is valuable protection for a buyer who may have accumulated substantial equity in a property.
• A buyer who has not done the foregoing and defaults is subject to being evicted as a tenant and all payments made under the land installment contract will then be construed as rent.
• Most land installment contracts provide that the buyer will make the payments of interest and principal at a rate agreed upon by the parties, and normally, the payments will equal or exceed the owner's own payments on the underlying first mortgage. Also, most sellers require that the buyer make additional payments for taxes and insurance rather than depending on the buyer to voluntarily make those payments which may pose a risk to the seller. It should be noted that sellers may wither (1) add the buyer to their existing homeowners insurance policy "as their interests may appear" or (2) have the buyers purchase a new policy again naming both seller and buyer "as insureds." This policy will ultimately end up int he hands of the lender who will require a copy and will be a tip-off that the property has been sold on a land installment contract basis.
• Ohio requires that ALL land installment contracts be recorded within twenty (20) days of their execution and this is very important protection for buyers who, without this recording, are subject to sellers encumbering the title to the property against their interest. this recording, as noted, will make the sale a matter of public record.
• Properly drafted land installment contracts will contain a provision, that while the seller may keep a mortgage on the property, the balance(s) may not exceed the balance owing on the land installment contract. Furthermore, buyers have the right to direct their payments to the mortgage holder int he event the seller fails to make the mortgage payments. It is important for the buyers to determine at the outset that the seller is current on the underlying mortgage obligation, as I have had two experiences int he past year where the seller took the buyers' land contract payments and never paid their lender, resulting in foreclosure. (This may be avoided by the buyers making the payment to the sellers' lender).
• Why I really like and recommend the land installment contract?
• Sellers can deduct the interest paid on the underlying mortgage(s)
• Buyers can deduct the interest paid on the land installment contract. **It should be noted that in many instances, sellers who sell their primary residence via land contract then have this former home re-characterized by the IRS as income or investment property. This should be the trigger for sellers to consult their tax counsel for the changes in how they prepare and file taxes. (Any interest sellers receive on a land contract payment will normally be treated as income but may be offset by any interest they pay on their loan... so, in many cases it results in no additional tax burden for sellers, but this varies from case to case.
• Lenders normally treat land contract buyers as owners when it comes time to refinance the land installment contract giving them more favorable rates and terms. Note that most lenders will require the land installment contract to be "seasoned" for varying periods from 6 months to a year or more.DO NOT get involved in any scheme to backdate this document as this constitutes fraud.
• Realtors can normally get paid their commission(s) from the initial closing of the land contract depending on the amount of monies pad down; however, this is a matter of negotiation between the various parties.
• Fees: Although fees can vary, I normally charge the following, depending on the location and whether it is unregistered or registered land with higher recording fees:
• Title Exam, document preparation and closing $350.00
• Recording fee: $85.00
• What information is needed:
• Contract to purchase: Simply prepare a standard contract (CABR has a contract checklist for land contract sale to assist in identifying necessary information) but in the financing section or Addendum, provide something like the following: "Seller agrees to provide financing in the form of a land installment contract with the following terms and conditions:"
• Sale price
• Down payment
• Interest rate
• First payment date
• Last payment date
• Monthly PI or PITI
• Other relevant information

The following information will also be needed:Sellers

• Sellers names as appear on the deed (copy of deed greatly appreciated) and mailing address for payments
• Purchasers' names and marital status, as well as contact information (email)
• Property address with zip code
• Name of mortgage lien holders and approximate loan balance(s).