Deed of Trust or Land Contract? Which is Better for a Land Buyer?
When buying land with seller financing, a deed of trust is better for the buyer while a land contract is better for the seller.
Buyers prefer a deed of trust because the property is titled in their name, which ultimately provides greater protection and control.
Comparison of a Deed of Trust and Land Contract
| Deed of Trust | Land Contract | |
|---|---|---|
| Buyer has title to the property? | ✅ | ❌ |
| Buyer can file for a building permit? | ✅ | ❌ |
| Better default protection? | ✅ | ❌ |
| Coordinated by a neutral third-party? | ✅ | ❌ |
| Requires a lower down payment? | ❌ | ✅ |
How Does a Deed of Trust Work?
A deed of trust is the standard financing instrument in the real estate industry. It’s exactly what’s used by banks and everyday home buyers.
When financing land with a deed of trust there are three parties involved:
Buyer
Seller
Neutral third-party trustee
The seller deeds the property to the buyer, and the trustee (typically a title company or attorney) holds a lien on the property. Once the buyer completes their payments, the trustee releases the lien on the property and the buyer owns it free and clear.
This type of financing provides the maximum security for a land buyer since they hold title to the property and the lien release is coordinated by a neutral third-party.
How Does a Land Contract Work?
A land contract is a relatively obscure financing instrument (used primarily in land sales) that provides more benefits to the seller, to the detriment of the buyer.
When financing land with a land contract there are only two parties involved:
Buyer
Seller
The seller keeps the title to the property, and the buyer only has a land contract. If everything goes according to plan, the seller deeds the property to the buyer once payments are completed.
However, given that land financing typically spans several years or more, a lot can go wrong in that timeframe. Buyers who only hold land contracts are at risk of:
Seller going out of business
Seller bankruptcy
Seller passing away
Seller becoming seriously ill or incapacitated
Seller neglecting to pay property taxes and forfeiting the property to the county
Sellers have the upper hand with land contracts since they retain title to the property until all payments have been made by the buyer. In addition, once a buyer has diligently made years of payments on a property, they have to hope nothing has happened to the seller or else their chances of getting the deed to the property decrease drastically.
Holding Title to a Property Provides an Advantage
Whoever holds the title to the property has more security and control.
When buying a property with a deed of trust, the buyer gets title to the property.
However, when buying a property with a land contract, the seller keeps title to the property until the very last payment is made.
Make Sure You Can Improve Your Land
Many buyers invest in raw land with the goal of improving their property in the future.
Local governments are very familiar with land improvement and have streamlined processes to help landowners with a variety of development projects such as:
Electric service
Septic or sewer
Well or water main
Building pad
Construction
To move forward with improvements, the landowner on record will need to sign off on the permit applications.
For people who’ve financed their property with a deed of trust this is no problem. They’re already on title and can sign the application themselves.
However, for those who’ve financed a property with a land contract they’ll need to ask the seller (who has title) to sign their name on an application that’s unfamiliar to them. Many sellers won’t sign these documents, which means the buyers must pay off their property before moving forward with improvements.
Choose the Best Default Protection
Deeds of trust provide more protection than land contracts.
In case of a potential default, there’s a lengthy notification process coordinated by the neutral third-party trustee. If no resolution can be found, a public sale of the property is coordinated by the trustee. If the property sells for more than is owed to the seller and trustee, the buyer receives a check for that amount.
On the other hand, land contract defaults have a relatively rapid notification and forfeiture process that’s coordinated by the seller. In the case of default, the buyer forfeits the property along with all payments made.
Coordinate with a Neutral Third-Party
Sophisticated buyers and banks choose deeds of trust when financing is involved. This is because there’s a trustee coordinating the transaction, payments, and lien release between buyer and seller. This neutral third-party ultimately reduces the potential for complications.
Land contracts are strictly between buyers and sellers, and buyers must hope a seller keeps their word to deed over a valuable property years later.
Down Payment Requirements
Deeds of trust require higher down payments while providing more security and control.
It’s time intensive and expensive to complete the default process on a deed of trust, given all the buyer protections. In turn, sellers require down payments starting at around 20% of the purchase price.
Alternatively, land contracts are quick and inexpensive to reclaim after default, since the seller already has title to the property. Some sellers will even accept down payments as low as $100 for less desirable properties, due to the ease of reclaiming a property. So while land contracts allow for lower down payments, it’s at the expense of protections and benefits otherwise gained through being on title.
Choose a Deed of Trust When Financing Land
Smart buyers choose a deed of trust when financing land, which ultimately provides greater protection and control.
At Budget Land we believe buyers deserve the benefits that come with a deed of trust. We’re here to support you in your journey of land ownership.