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The www.FedPrimeRate.com Personal Finance Blog and Magazine

Tuesday, December 08, 2009

Land Contract: A Great Alternative When A Traditional Mortgage Isn't An Option

No one understands the current state of the U.S. housing market more than the citizens of California, Florida, Illinois, and Michigan. Recent statistics show that the combined foreclosures of these four states represent 52% of all foreclosures in the nation (Grand Rapids Press). Americans living in these states are experiencing a housing crisis like this country has never seen, primarily due to a combination of high-risk mortgages, negative equity, and unemployment. This perfect financial storm brooding over the U.S. economy has rained heartache and headache upon countless families over the past few years, and reaches far beyond the realm of only the fiscally irresponsible. I ought to know – I lost my own home to foreclosure in 2008.

When I got married in 2004 I moved to West Michigan with my husband, a first-time homeowner who had acquired a low-cost property and performed major renovations himself in order to keep a low monthly note and gain equity fast. By the time we were married he was enjoying the fruits of his labor and, as far as he knew, doing well. He was the first person in his immediate family to own a home with a 30-year mortgage. His father, a General Motors retiree, had always lived beneath his means so that he could pay cash for almost everything, including his home. The short-term mortgage that his father did have was paid off early, so loans were not his specialty. That’s why my husband had made a fatal mistake before we got married – he refinanced his home during the big predatory refinance boom.

Borrowing against the additional equity in his home, my husband refinanced with a low introductory interest rate on an adjustable rate mortgage (ARM) with an option to refinance again in two years. His plan was to refinance again in two years and acquire a fixed rate mortgage at as reasonable rate as he could get. The money he was able to pull out of the house was used to pay off bills and theoretically create a better financial situation for him and the family he hoped to build soon. With a degree in Business Finance, my husband was not a novice when it came to loans and how they worked. Unfortunately, caught up in all of the advertising and marketing hype of that time, he forgot that he did not have a crystal ball or a prophecy ensuring his financial security two years down the road. Like so many other borrowers in Michigan at that time, he allowed emotions and predatory lenders to convince him of future financial security that was not promised. Subsequently, the house of cards began to fall.

Soon after refinancing we were married and were blessed with our first child within a year. This addition coupled with disappointment in the lack of upward mobility at his job created a great strain on our finances because bills were growing but income was not. A few missteps with his credit plus a bursting housing market bubble and before we knew it, our chances of refinancing when we wanted to were ruined. We were stuck with the balloon payments and a monthly note that we could no longer afford. We succumbed to foreclosure in 2008 and had to move into an apartment that cost more per month in rent than my husband’s original mortgage payment.

The funny thing about it all was that my husband remained optimistic that something would work in our favor soon. While the media was predicting doom and gloom henceforth and forever because of the mortgage industry ‘crisis’, my husband had some foresight that would soon become a sigh of relief – but not without a little intermittent pain to endure. We had to live in a cramped duplex for a year with then three children (twins were born while we were going through the foreclosure process) and although our living space was nice, it was simply too small. However, after gaining a more solid foothold on our finances, with badly tarnished credit and a foreclosure to boot, my husband began looking for a new home to live in. He was able to sense what many economists could not – the changes in the housing market would cause other subsequent changes that would essentially benefit even buyers with bad credit. It was obvious that buyers with good credit would be able to scoop up great properties for pennies on the dollar because of the spike in foreclosures. However, what most market watchers did not predict was the need for property owners who wanted to sell to adapt in order to survive. In the states with the highest amount of foreclosures there are more properties than buyers, and seller who own their properties free and clear or who have good credit but own more property than they are willing to manage now find themselves needing to liquidate these assets without losing too much money.

In comes the land contract, here to save the day!

In his quest for a home to rent my husband found a nice homeowner who was eager to sell, and had no one to sell to. After a few honest, productive conversations, we found ourselves in a position to get a new home that was bigger and worth at least $50,000 more than the one we had lost, without having to rely on a bank for a mortgage loan. The seller was willing to make an arrangement where we could rent with an option to buy, with no interest added to the selling price of $107,245. The deal works well for both parties. The seller is an older man who can no longer maintain his properties the way he needs to. The house we now occupy needs a little maintenance and aesthetic work as well as a new roof in a couple years. So, the option consideration clause of the lease/purchase agreement that requires a non-refundable payment of $3,000 is absorbed by the repair allowance which totaled $7,250. This exchange empowered us to move into the home without paying the lofty contract fee; we maintain control over the repair costs and we will schedule for the renovation work that needs to be done. If for any reason we were to default on the agreement, the renovation that we perform adds equity to the home, not to mention the extra $750 per month the seller stands to make as long as we stay, putting him in a better position than when he entered into the contract. This causes his risk to be minimized and our benefit to be maximized, so long as we maintain our end of the agreement, which we have done and will continue to do. Without good credit and without the help of a lending institution, we have a better home to live in and are on the road to financial recovery.

Although this arrangement is not the conventional road to home ownership, in the State of Michigan, where unemployment is the highest in the nation at a rate of 15.1% (as of October 2009 - Bureau of Labor Statistics) and foreclosures are in the top five U.S. states for number of filings (RealtyTrac), it is a welcome alternative. Prospective buyers in similar positions may find that there are more flexible sellers and renters out there than they thought. It takes some struggle, some research, and some faith, but when the market changes this drastically, buyers can still find sellers who are willing to do what banks and economists thought was virtually impossible – adapt and accommodate.

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Anonymous Land Contract said...

It's great that you were able to get into a home with bad credit and a foreclosure, AND bypass the banks that caused this Great Recession.

A land contract is actually the same way consumer financing is done in the Islamic world. Under Sharia law, if you want to buy a home, the bank will purchase the home for you, then add a reasonable premium -- which serves are their profit. You, the buyer, then pays the bank back over time with installment payment. It's a far more just system, because the bank makes money without charging overbearing interest. Check out any mortgage calculator and you will see what I'm talking about. With most 30-year mortgages, by the time the buyer pays off the note, the buyer has paid as much in interest as the price of the home. It's a truth about Western finance that has always bothered me.

I'm not a Muslim, and there a lots of things I don't like about Islam. But I do like the way they handle consumer financing. BTW: Islamic banks protect themselves from default by having very strict rules regarding collateral.

Tuesday, December 08, 2009 10:26:00 AM  
Blogger Leslie James said...

That is an interesting take on our situation, Land - I had never heard of Sharia Law before you brought this up.

I wonder if banking this way only produces moderate profits? If it didn't it seems like someone over here would have tried to implement it a long time ago in order to provide some sort of competition to the interest banking system. That kind of alternative bank could make a LOT of money by the sheer volume of customers who wish to escape exorbitant interest rates.

BTW, I like that "Great Recession" - I didn't catch it at first, but that was pretty witty ;-)

Wednesday, December 09, 2009 11:50:00 PM  
Blogger Steve said...

This is great information. Thank you for getting this information out. With the current economic crisis, there are many that could benefit from using a land contract. Thanks again.

Debt Help FL

Thursday, December 10, 2009 9:19:00 AM  
Blogger john said...

Western mortgage practices may seem unreasonable but it does allow money to move and be invested. It is when these practices are misused and high risks are taken that we find ourselves in debt and defaulting on loans. There is a wealth of information on debt, debt relief, bankruptcy, finance, and much more at www.credit-advisors.com

Wednesday, December 23, 2009 3:43:00 PM  

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