An option for the sale or purchase of Ohio real estate is the use of seller financing. Some sellers for various reasons may wish to provide the financing for the sale of their property instead of having their buyer seek traditional financing through a banking institution. Many new real estate investors may not have enough money for a down payment to purchase an investment property with a conventional loan.
Typically, lenders will require at least a 20% down payment for loans to purchase non-owner-occupied investment properties. When factoring in closing costs, repairs, renovations, reserves, etc., the 20% down payment requirement can sink a new investor’s budget and discourage a new investor from purchasing an investment property. However, an investor may be able to find a seller who is willing to sell an investment property to a buyer by seller financing without requiring a 20% down payment either by a land installment contract or a note and mortgage to the Seller.
Land Installment Contract:
A land installment contract in Ohio is a form of seller financing defined under the Ohio Revised Code Section 5313.01(A) as follows:
“Land installment contract” means an executory agreement which by its terms is not required to be fully performed by one or more of the parties to the agreement within one year of the date of the agreement and under which the vendor agrees to convey title in real property located in this state to the vendee and the vendee agrees to pay the purchase price in installment payments, while the vendor retains title to the property as security for the vendee’s obligation. Option contracts for the purchase of real property are not land installment contracts.”
As indicated in the statute above, the “buyer” in a land installment contract is called a “vendee”, and the “seller” in a land installment contract is called a “vendor.” As in a regular purchase contract, the seller and the buyer in a land installment contract agree to the purchase and sale of a property. However, a land installment contract differs from a regular purchase contract in that possession of the property typically transfers to the buyer upon execution of the land installment contract. The deed transfer in a land installment contract does not occur until after the buyer has paid all installments in accordance with the terms of the land installment contract. Although the land installment contract is recorded in the public records, the seller remains the title owner of the property. This feature may give a seller an incentive in providing the financing to the buyer.
Upon execution of the land installment contract, the buyer pays the seller a down payment agreed upon in the land installment contract, and then makes monthly installment payments to the seller that will be credited towards the outstanding balance of the purchase price. Since the amounts of the down payment and the installment payments are negotiated during the finalization of the land installment contract, the parties may agree that a down payment of less than 20% of the purchase price is acceptable, making the property affordable to the buyer. The buyer will presumably have more cash for closing costs, repairs, renovations, reserves, etc., than with a conventional loan.
At the end of the term of a land installment contract, the buyer is required to pay the outstanding balance of the purchase price to the seller, and the seller is required to transfer title to the buyer by a deed transfer. This explanation delineates the basic terms and structure of a land installment contract, but there are many other essential terms that must be considered by the parties. It is essential that the parties be represented by an experienced real estate attorney before entering into any land installment contract.
Note and Mortgage:
A note and mortgage to the seller (“Note and Mortgage”) is more analogous in structure to a conventional loan than a land installment contract. When using this form of seller financing, the seller in a real estate transaction simply functions as the lender. The buyer and seller enter into a real estate purchase contract, whereby the seller agrees to provide financing to the buyer to purchase the property. The terms of the Note and Mortgage should be negotiated in the real estate purchase contract. It is best that those terms be specific in order to avoid arguments at closing.
An experienced Ohio real estate attorney can specifically draft these documents for the closing. The contract may specify the form or may indicate that the Note and Mortgage must be in the form acceptable to one of the parties; usually that party is the seller. Standard forms of a note and mortgage promulgated by Fannie Mae, or more commercial versions of a note and mortgage used by conventional, commercial banks may be used, but an experienced real estate attorney should analyze those forms and design language that make the forms fit the transaction at hand.
As in the discussion of land installment contracts, the parties may agree to a down payment under 20% of the purchase price of the real estate. Thus, reserving the buyer’s cash for closing costs, repairs, renovations, reserves, etc.
At the closing of a real estate transaction using a Note and Mortgage, the buyer grants a mortgage to the seller and executes a promissory note in favor of the seller. By granting a mortgage to the seller, the buyer gives the seller a security interest in the real estate, just like a buyer would do for a lender when using a conventional loan to buy a property. Unlike a land installment contract, the seller in a deal using a Note and Mortgage transfers title to the real estate to the buyer at a closing, and retains a security interest in the property.
While both a land installment contract and a Note and Mortgage can be negotiated to allow a buyer to come up with less cash at closing, they are fundamentally different in structure and each have their own nuances and risks which buyers and sellers should be aware. Retaining an experienced real estate attorney is essential to structure and consummate these transactions. We explore some of those nuances and risks in more detail in Part II of this article.