A mortgage alternative for lower-priced homes comes with risks

Seller-financed loans known as “land contracts” don’t involve a bank and lack the consumer protections available with traditional home loans.

With traditional mortgages for lower-priced homes hard to get, some home buyers are turning to riskier alternatives, like seller-financed loans known as “land contracts” that don’t involve a bank.

About 1.4 million Americans have active land contracts, a type of financing in which buyers don’t get full legal ownership of a home until they make their final payment, according to a new report from the Pew Charitable Trusts. Pew has estimated that 8 million people have used the contracts to pursue homeownership.

Some buyers prefer land contracts because they can be arranged quickly and often have lower upfront costs than mortgages. They also offer an alternative to buyers who can’t qualify for a traditional home loan because of poor credit.

But the arrangements lack consumer protections available with traditional home loans and can leave buyers worse off financially, Pew found. The report was based on a survey of buyers as well as interviews with dozens of public-interest lawyers in 26 states who have represented buyers.

With land contracts, the home buyer agrees to pay a certain amount of money at a given interest rate over time. Data on interest rates for land contracts are hard to come by, Tara Roche, project director of Pew’s housing policy initiative, said, but what information is available shows “somewhat higher” interest rates than for mortgages.

The terms vary and can be as short as five or 10 years or as long as 30 years. Most are used to buy properties valued at less than $150,000, where traditional mortgages are hard to get, largely because small home loans are less profitable, Ms. Roche said. (Researchers have found that the arrangements are concentrated in lower-income neighborhoods with scant levels of mortgage lending.)

In a land contract, unlike conventional financing, the deed to the home remains in the seller’s name until the buyer has paid the entire purchase price. If the buyer is late or misses a payment, the seller can cancel the contract and evict the owner. (Conventional mortgages typically go through a foreclosure process, in which borrowers have an opportunity to get back on track and keep their home.) Some contracts have large balloon payments at the end that buyers may struggle to afford.

Land contracts are lightly regulated by a patchwork of federal and state laws, Ms. Roche said. Fewer than half of states have laws governing the agreements. In most states, the contracts don’t have to be recorded in a public registry, as conventional mortgages do. Even in states that require it, compliance can be spotty, so documentation is often lacking.

The agreements are often one-sided. Buyers typically pay property taxes and insurance and handle repairs, even though they don’t have full title to the property.

But people may not realize that they don’t have the title to the property, said John Green, managing principal with Blackstar Stability, a real-estate investment company that works with residents to convert land contracts into conventional mortgages. Rather, they think they bought the home, so they behave like real owners, often spending significant sums of money to repair and renovate the houses.

That means buyers can lose their entire investment if they fall behind on payments, said Kate Woomer-Deters, a senior attorney at the North Carolina Justice Center in Raleigh. Because buyers’ names aren’t on the deed, they can’t simply sell the home if they run into financial difficulty.

Sellers — sometimes mom-and-pop operators, but increasingly larger companies — know they are offering something attractive to buyers, lawyers say. “They have the allure of homeownership, and that is a very powerful thing,” said Patrick Skilliter, senior managing attorney at Legal Aid of Southeast and Central Ohio, in Columbus.

Mr. Skilliter recently represented Brandon Kelso, 32, who had been paying a land contract for a small, two-bedroom house in Columbus.

Mr. Kelso said in an interview that he had first taken over payments on a prior land contract signed by his father, who died in 2017. When the seller allowed him to continue making the payments after his father’s death, Mr. Kelso said, he was “excited” because it meant he could remain in the home where he had lived since 2012. Mr. Kelso said he had understood that the property owner would be responsible for paying property taxes on the home. But in June 2020, Mr. Kelso received notice that a lien had been placed on the house. When the owner began eviction proceedings, Mr. Kelso sought legal help.

His eviction case was resolved with a new land contract with the seller, which Mr. Kelso signed in November 2020, according to court documents. Under the new contract, filed with the county recorder of deeds, Mr. Kelso agreed to pay $300 a month, with a final payment of $53 due in July 2023, after which he would own the house.

But when Mr. Kelso mailed his final payment last year, the postal service returned it as undeliverable, court filings say. “The seller basically disappeared,” Mr. Skilliter said.

Legal Aid filed suit asking a court to recognize Mr. Kelso as the owner, in what’s called a “quiet title.” On July 10, the court found in Mr. Kelso’s favor, granting him “all right, title, ownership, and all other interest” in the property. Mr. Kelso said he was relieved. “It was really stressful,” he said.

In a separate case, Dolores Lawson, 59, lost her mobile home in Garner, N.C. Ms. Lawson, who works as an administrative assistant, said in an interview that she visited the mobile home park in early 2019 to inquire about renting a unit. Instead, she was offered an option to purchase one under an agreement that lawyers say is the equivalent of a “contract for deed,” or land contract, under North Carolina law.

Ms. Lawson agreed to a $2,713 down payment, plus 60 payments of $407 a month. “After that, the home would be mine,” she said. (She also agreed to pay monthly rent of $475 for the land underneath the home.)

But after she moved in, in March 2019, she found that the property, a 26-year-old, single-wide manufactured home, lacked insulation. “Imagine being in a tuna can in the summer and a deep freeze in the winter,” Ms. Lawson said. When her mother became ill later that year, Ms. Lawson used her own money to help pay for her mother’s care. “I fell behind on my payment,” she said. In October 2019, she was evicted and moved into a rental apartment.

She will soon get at least some of her money back. A federal court in March finalized an agreement to settle a class-action lawsuit brought against her mobile-home park’s owner, Riverstone Communities, by the North Carolina Justice Center and the National Consumer Law Center. The suit claims that the installment purchase contracts given to the park’s residents were structured to skirt consumer and tenant protections. The settlement includes a payment of more than $1 million to compensate about 200 park residents, including Ms. Lawson, who was one of the lead plaintiffs. Riverstone did not respond to requests for comment.

Here are some questions and answers about land contracts:

“Don’t enter into one of these at all,” Ms. Woomer-Deters advised, because there are typically few protections if something goes wrong. She said she is now in litigation representing clients who signed a land contract — only to have the owner sell the property to someone else. At the very least, she said, a lawyer should review the document before you sign and have it publicly recorded. It’s worth paying upfront to avoid costly problems down the road, she said.

Land contracts are often referred to by various terms, which adds to the confusion. For instance, they are sometimes called “contract for deed” arrangements or “land installment contracts.”

Proposed federal legislation would expand protections for people who use land contracts to finance the purchase of a home. The Preserving Pathways to Homeownership Act of 2024, sponsored by Senators Tina Smith, Democrat of Minnesota, and Cynthia Lummis, Republican of Wyoming, would require contracts to be publicly recorded within five days of signing. It would also grant foreclosure protection to contract buyers who can’t make necessary payments, giving them the chance to catch up.