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Michigan Land Contract vs. Lease with Option to Purchase: Which is better for the Seller?

Land contracts are a very popular way to transfer property, with 397 land contracts recorded in Muskegon County during 2012.  The most common use for a land contract is providing short term seller financing when a potential buyer is unable to obtain traditional bank financing.

A land contract commonly provides for a down payment around 10% of the purchase price, a term between 2 and 4 years, and a balloon payment of the remaining balance due at the end of the term. The idea is that the buyer will be able to clean up his or her credit in that time period, and then be able to obtain traditional bank financing for the remaining balance.

If everything goes as planned, a land contract can be a win-win for both the buyer and seller. The buyer is able to start building equity in a house and improving his or her credit rating, while the seller is able to receive interest payments. Unlike a landlord/tenant relationship, the seller is often no longer directly responsible for maintenance of the property because the buyer owns equitable title to the property.

But what happens if things don’t go according to plan? What if the buyer loses their job and can’t pay anymore? What if bank financing is still not available at the end of the term? What if the seller has an existing mortgage on the property? With that in mind, it may have been simpler for the seller to have signed a lease with option to purchase, rather than a land contract.

A lease with option to purchase can be structured similarly to a land contract, providing an option payment around 10% of the purchase price due at lease signing, and a term between 2 and 4 years, during which the buyer can exercise the option to purchase for an agreed upon price. If the buyer decides to exercise the option, the option payment and a portion of the monthly lease payments can be applied to the purchase price.

In the event the buyer defaults, a lease with option to purchase proves advantageous to the seller. When the buyer defaults on a land contract, the seller can either start a forfeiture or foreclosure proceeding. A land contract forfeiture does not allow for collection of past due amounts or acceleration of the remaining balance, and the buyer has a three or six month redemption period after a judgment is entered by the court.

While a land contract foreclosure allows for recovery of past due amounts and acceleration of the balance, it is a long and expensive process, taking up to a year before the seller regains full control of the property after the redemption period. With a lease default, the waiting period for eviction after obtaining a court order is only 10 days, instead of the minimum three to six month redemption period for a land contract judgment.

Due to the much shorter time frame for the seller to gain back control of the property, while still keeping the option deposit that was paid up front and obtaining a judgment for the lease payments, a lease with option to purchase should always be considered before a seller enters into a land contract.

If you are thinking about selling your property directly to a buyer through a land contract, I am available to discuss your specific situation and determine the best available option. Next month we will look at this same issue from the perspective of the buyer.

For any questions, contact us today.