A contract for deed is a private agreement between a landowner (a seller) and a buyer that allows the buyer to purchase land over time without a traditional bank mortgage loan. Generally, the buyer agrees to pay for the land through a series of installment payments made over a number of years. Although a contract for deed may seem attractive to a buyer who needs farmland right away but lacks a down payment and/or cannot qualify for a traditional bank loan, a contract for deed arrangement can be risky because the buyer does not actually obtain legal ownership of the land until the buyer makes the very last payment under the contract. So, for example, if a buyer misses one payment in year 29 of a 30-year contract for deed agreement, the buyer could lose the right to own the land in year 30 – even though the buyer made payments faithfully for 29 years.
Due to the long-term nature of most contract for deed relationships, a successful contract for deed transaction requires a great deal of trust and cooperation between the landowner and the buyer. Additionally, it is important to note that a contract for deed arrangement could prevent a landowner (seller) from being eligible for Medicaid because the landowner retains legal ownership of the land (at full value) until the end of the contract term. Consequently, the entire value of the farmland would likely count toward the Medicaid asset limit.
In sum, contracts for deed can be risky for both the buyer and the seller, and should not be entered into without careful consideration of the factors involved in each unique situation, thoughtful attention to the wording of the contract for deed, consideration of other potential land transfer options, and planning for the possibility that the contract could be terminated before the buyer gains legal ownership of the land.
Having fled their home countries, New Americans in Vermont had difficulty obtaining fresh goat meat and vegetables from their own countries.
A contract for deed (also called a “land contract,” “land sale contract,” “installment land contract,” “bond for deed,” or “installment sale”) is a private contract arrangement in which a buyer pays a seller (landowner) the purchase price of the seller’s property in installments and without the involvement of a third-party lender (like a bank). A contract for deed buyer generally takes immediate physical possession of the property, and could start farming the land right away. However, a contract for deed buyer does not receive title to the property immediately. In fact, the buyer does not own the property until the full purchase price is paid according to the contract. Even though the buyer might be farming and living on the land, a contract for deed buyer does not become the legal owner until the final installment has been paid. Instead, the seller continues to legally own the property until all payments have been completed.
Achieving ownership under a contract for deed takes as many years as the buyer and seller agree to under the contract, so a buyer could make payments for 15, 20, 30 years or more before achieving ownership of the land. In addition to the potentially decades-long wait for ownership, contracts for deed can be risky for buyers because failing to make a payment can cause the buyer to lose the land. If a contract for deed buyer fails to make a payment, the seller would likely be able to take back the property and, in many states, keep whatever installment payments have already been made.1 So, while contracts for deed might be attractive to farm-seekers who cannot – or do not want to – obtain a bank mortgage loan, they come with the risk of losing the right to own land that you may have farmed for many years, and the value of all of the payments you have made over the years under the contract for deed.
In a traditional farm sale, a landowner (seller) would immediately receive the full purchase price, usually in the form of a smaller down payment from the buyer plus the proceeds from a larger bank mortgage loan. In return for the full purchase price, the seller would give the land deed to the buyer, transferring legal ownership and title to the buyer. After this transfer, the seller would no longer have any claim to the land or involvement with the buyer. Instead, only the buyer (and the bank, under the terms of the mortgage loan), would have any claim to the property. The buyer would be required to make mortgage payments to the bank until the mortgage loan (plus interest, fees, etc.) was paid off. The bank would use the land (and any buildings on the land) as collateral for the loan, and if the buyer failed to make mortgage payments the bank could require sale of the property in order to pay off the remaining balance of the mortgage loan (generally called a foreclosure process). Even in a foreclosure situation, though, the buyer would receive credit for the mortgage payments made to the bank over the years (in the form of equity) and therefore the buyer would likely not lose the entire value of the mortgage payments already made to the bank. Additionally, there are many well-settled laws and regulations that cover default and foreclosure related to a mortgage loan, and some protections for buyers are built into those laws.
In contrast to a traditional sale arrangement, in a contract for deed setting the landowner (seller) does not receive full payment up front and does not immediately transfer ownership of the land to the buyer. Instead, the seller essentially stands in place of a bank and agrees to “finance” the land transfer by 1) accepting smaller installment payments over time (instead of full payment up front), and 2) keeping ownership of the land until the buyer makes the very last payment under the contract.
In a contract for deed scenario, the seller keeps full ownership of the property until the buyer makes the very last payment, and the buyer could lose any right to own the property by failing to make even one payment under the contract. Furthermore, in comparison to the laws related to a traditional sale, the laws related to contracts for deed can be unclear, less developed, and can lack protections for buyers who fall behind on contract for deed payments.
A contract for deed buyer should be very careful about the wording of the contract for deed and should try to negotiate buyer protections within the terms of the contract for deed agreement itself. Additionally, in some states, a contract for deed buyer could eventually recapture the value of the payments made to a contract for deed seller (under what is called an “equitable mortgage” defense), but the buyer would likely need to pay a lawyer and possibly go to court in order to successfully obtain this type of reimbursement.
Traditional Sale vs. Contract for Deed Comparison Summary
Contract for Deed
Some farmers are drawn to contract for deed arrangements, especially among close family and friends, because they seem like “less of a hassle.” Contracts for deed may seem easier to handle up front, because they are private arrangements that allow buyers and sellers to avoid dealing with bank officials, realtors, considerable paperwork, down payments, closing costs, administrative hassles, and more. Sometimes, buyers and sellers draw up the contract for deed by themselves and do not involve a lawyer.
Clearly, this strategy costs less up front – both in time and in money. However, the long-term cost of using a contract for deed to purchase land can be financially and emotionally harmful. For a contract for deed buyer, the possibility of 1) losing the land they have farmed for years and consider to be “theirs,” and 2) losing their “investment” in the land (all of the payments made under the contract for deed over the years, their labor, and any improvements made to farm buildings or other structures) is a big risk with serious consequences.
Farm-seekers considering a contract for deed arrangement should consider all of the risks and other land access options first, and should seriously consider asking a lawyer to draft the contract for deed agreement (or at least review the agreement and suggest edits). A comparatively small investment in legal advice up front could save money and heartache in later years. For example, an individualized contract for deed drafted by a lawyer could require the seller to return all or part of the payments made under the contract if the contract terminates for any reason.
A contract for deed is a method of transferring property between a buyer and seller without the involvement of a third party lender (such as a bank). Under the contract, the buyer provides the seller with installment payments toward the purchase price over a certain period of time in exchange for immediate physical possession and use of the property. The buyer does not receive legal title to the property (ownership) until the buyer pays the full purchase price.
Practical Tip: It is helpful to draft a payment schedule listing all principal and interest payments and payment dates through the end of the contract for deed term (e.g., for all 20 years of the contract term, up to the last payment in year 20). This can be done by hand, by a computer word processor, or in a spreadsheet.
Example: Choose Your Own Contract for Deed Adventure
DIY Contract for Deed
A landowner seller and a farmer buyer agree to a contract for deed sale that requires the buyer to pay the landowner $540,000 in a series of installment payments of $3,000 a month made over 15 years. The buyer can start farming the land immediately, can move into the farmhouse on the land, and can make improvements to the farm buildings on the property.
The seller keeps legal ownership of the property, but moves to a neighboring state to be closer to her grandchildren. The seller plans to rely on the buyer’s monthly $3,000 payments as her retirement income. The buyer and seller used a form they found on the internet to document this agreement; they did not have a lawyer review the contract.
Unfortunately, in year 12 of the contract, the buyer hits hard times. After having paid $432,000 to the seller, invested $68,000 in renovating the farmhouse, and spent thousands of hours working the land, building a CSA farm business, and improving the soil, the buyer cannot continue making required monthly payments.
When they looked back at the contract that the buyer and seller found on the internet, they found that it included a forfeiture clause. This clause says if the buyer misses a payment, the seller can keep all payments AND take back possession of the property and all improvements.
As a result, the buyer loses the right to farm the land, loses his $432,000 paid over 12 years, loses the $68,000 invested in farmhouse renovations, and loses all of the hours invested in the land and the business. The buyer has to move and look for a new farm. His CSA farm business is based on local customers, and if he can’t find new land locally, he will have to start building his business reputation from scratch in another location.
The seller, who has retired and moved to a new state, is left without monthly payments. She cannot farm the property herself, so she is left without income until she can sell the land, find a renter, or find another solution.
A Lawyer Could Have Helped Create A Better Ending
The buyer would be in a much better position if he had negotiated language in the contract for deed stating that if the buyer could not make payments, the seller would sell the land, and the buyer would get back at least a portion of his $432,000 (perhaps calculated in relation to the sale price) and perhaps also some credit for improvements made to the property (farmhouse renovations).
The seller would have to be careful to agree to repayment only upon a successful sale. The seller would also need to be careful not to agree to repay the payments immediately, because she likely already used the money to live on in retirement. Agreeing to sell the property and repay the buyer only when the property is sold could protect both the seller and the buyer, assuming a sale is possible.
The bottom line is that lawyers can help draft contract for deed language that protects both parties in case a buyer can no longer make payments. It can be dangerous to sign a contract with language that neither party truly understands and that a lawyer hasn’t reviewed.
Compare to a Traditional Sale
If the buyer had engaged in a traditional purchase of the property financed by a bank loan and couldn’t make mortgage payments, the buyer could likely get back a significant portion of his investment in the property. The bank would sell the property to pay off the loan balance, and the buyer would receive the value of his equity in the property, minus fees, missed mortgage payments, and penalties.
As in all private agreements, most terms contained in a contract for deed agreement should be up for negotiation. Sellers and buyers should carefully think through the terms of contract for deed agreements, which should generally contain at least provisions addressing the following:
Note that it is generally up to the buyer to assume tax and insurance responsibilities, but that should be up for negotiation.3 Additionally, the seller is required to convey the property to the buyer after the last payment has been made, usually through a warranty deed. The seller should also provide an abstract showing good title at the time of contract formation. The contract can also include protections for the buyer, such as a grace period for late payments, a foreclosure process, or other safeguards.4 Some states, like Ohio, require that contracts for deed contain certain standard provisions and disclosures and provide a helpful list of required provisions. This list is a good starting place for all contracts for deed, but it is also important to check the state law requirements in the state where the land is located.5
Sometimes, contracts for deed allow smaller payments over time but include a large balloon payment at the end of the contract. The balloon payment might not be affordable for the buyer even at the end of the contract, and failure to pay the full balloon amount could cause the buyer to lose the right to own the property at the end of the contract – even if all other payments have been made. Buyers should seek to avoid balloon payments, if at all possible.
Other common types of contract for deed provisions that provide strong protections for the seller but can significantly increase risk to the buyer include:6
The principal risk for a seller in a contract for deed setting is that the buyer will become unable to make payments. However, considering that sellers retain legal ownership of the land until buyers make full payment, and further considering that sellers often have the forfeiture remedy described above (allowing sellers to take back the land and possibly keep the contract payments), the risk to sellers is moderate. Landowner sellers may be particularly worried about buyer non-payment in relation to beginning farmers, but where forfeiture may not be available either under the terms of the contract or under state law, the USDA Land Contract Guarantee program may be helpful. The USDA Land Contract Guarantee program, understanding that a contract for deed may be the only practical option for beginning farmers without the capital or credit required for a traditional sale, offers guarantees to the owner of a farm who wishes to sell real estate through a contract for deed to a beginning farmer/rancher or a farmer/rancher who is a member of a socially disadvantaged group. The USDA Land Contract Guarantee program could also be helpful in an unlikely but possible scenario where the market value of the land drops significantly between the time a contract for deed agreement is signed and the time of potential forfeiture.7
Even though general state contract laws govern contract for deed arrangements, some states impose requirements designed specifically for contracts for deed. For example, in Minnesota, a buyer must record the contract for deed agreement with the county within four months of executing the contract.8 In Louisiana, if the property has any liens on it, a buyer must make the contract for deed payments to an authorized bank serving as an escrow agent.9 Ohio requires a seller to produce a statement of the payment schedule’s current status at least once a year or at the buyer’s request.10 Iowa requires contract for deed sellers to provide notice of forfeiture, which specifies the violation and gives 30 days to cure the default. Missouri requires a foreclosure process, which may take two to three months.11 These are just a few examples of state contract for deed requirements. Contract for deed sellers and buyers should check the specific laws of the state where the farm is located.
|Lease-To-Own||Contract for Deed||Traditional Sale (With a Bank Mortgage Loan)|
|Time||Will likely be long term, but there are short term lease-to-own farm leases.||Depends on the contract, but generally long term.||Short term; land transfers at time of sale.|
|Ownership||Owns only the right to purchase the land at the end of the lease.
Some leases may have also include a purchase and sale agreement where the tenant agrees up front to buy the land at the end of the lease.
|Seller retains legal title until all payments are made under the contract for deed.||Buyer gains legal ownership at time of sale.|
|Ownership Interest||Tenant may have the option to purchase or may make a firm agreement to purchase at the end of the lease term.||Buyer does not have a legal ownership interest until all payments are made. Depending on state law, the buyer may have an “equitable interest” in the property to the extent payments have been made under the contract.||Buyer gains ownership at time of sale.
However, the bank that provided the mortgage loan will generally use the land as collateral for the mortgage loan, and can foreclose if the buyer gets behind on the mortgage.
|Taxes||Tax responsibility may vary depending on the landowner’s involvement in the operation, and the terms of the lease.||Generally, the buyer is required to pay property taxes, but the terms of the contract will determine tax obligations.||The buyer is responsible for property taxes.|
|Startup Costs||Leases typically require rental payments, so the farmer leasing the land needs funds to pay rent on a schedule agreed upon in the lease.||Installment payments are generally similar to those of a lease or mortgage loan; the contract for deed buyer needs funds to make regular payments.
Payments are not necessarily monthly; they could be seasonal, quarterly, or any other schedule the parties agree upon.
|Generally requires a down payment and regular monthly mortgage loan payments to the bank.|
|Interest Rates||Generally no formal interest rate, but lease term may be set to provide the landowner with a profit (after paying any taxes, operating expenses, and mortgage expenses).||Generally higher than traditional bank interest rates to account for greater credit risk and buyer non-payment risk.||Determined by credit rating of mortgage loan applicant. Generally tied to federal reserve rates; may be variable over time.|
|Cancellation Risks||The leasing farmer may choose not to buy the farm, so the landowner farmer should have back-up plans in case the landowner still owns the farm at the end of the lease period.||If the contract has a forfeiture clause, the seller may have the right to cancel the contract and keep all of the buyer’s previous payments. A buyer may protect him/herself from this result by including specific protective contract provisions.||The sale generally cannot be cancelled, but if the buyer fails to make mortgage payments the bank could repossess and sell the property via a foreclosure process.|
|Back-Up Plan||The leasing farmer (tenant) may not choose to buy the farm, so the landowner farmer should have back-up plans in case the landowner still owns the farm at the end of the lease period. The back-up plan could be a new lease or an outright sale.||Buyers and sellers should consider including provisions in their contracts that address their rights and protections in the event of contract cancellation, non-payment, or other breach.||In the event that a buyer cannot make mortgage loan payments, the property would likely be sold.|
|Legal Recourse/Protections||Only those within the lease itself, and any state laws that regulate leases.||Some states provide specific protections for contract for deed buyers, and the contract itself can provide protections if properly drafted.
In the event of missed payments, some states provide buyers and sellers rights similar to traditional foreclosure protections.
|State and federal laws regulate property sales, bank lending, and foreclosure.|
If a traditional mortgage is possible, does the contract for deed offer better terms?
What is the likelihood you can afford:
What protections does the contract or state law provide in the event of missing a payment?
What is the value of the property being sold and is it likely subject to appreciating (increasing in value) or depreciating (decreasing in value) during the term of the contract for deed?
Will foregoing a lump-sum down payment cause financial difficulties?
It’s not an attorney’s job to make decisions for farmers or to set farm transfer goals. Instead, attorneys can provide information about pros and cons of different options, advice about what is common versus unusual, fair versus unfair, etc. Attorneys can help farmers understand the universe of possible farm transfer goals and help narrow down individual options so that farmers can make final decisions.
1. Phillip L. Kunkel, et. al, Mortgages and Contracts for Deed, University of Minnesota Extension Farm Legal Series (2015), http://www.extension.umn.edu/agriculture/business/taxation/farm-legal-series/mortgages-and-contracts-for-deed/docs/mortgages-and-contracts-for-deed.pdf .
2. “Land Contracts for Beginning Farmers: A Drake Ag Law Primer,” Drake Agricultural Law Center (2011), http://americasnewfarmers.org/wp-content/uploads/2011/09/land-contract-primer.pdf .
3. Heather K. Way and Lucy Wood, Contracts for Deed: Charting Risks and New Paths for Advocacy, J. Affordable Housing & Community Dev. L. (2014), at 37, 38.
4. See Ed Cox, “Land Contracts for Farmland: Advantages and Risks,” MOIAFarmLaw.com, http://moiafarmlaw.com/262.
5. Ohio Stat. § 5313.02 (Required provisions of land installment contracts).
6. See “Risks and realities of the contract for deed,” Federal Reserve Bank of Minneapolis (2009), https://www.minneapolisfed.org/publications/community-dividend/risks-and-realities-of-the-contract-for-deed.
7. See Ed Cox, “Land Contracts for Farmland: Advantages and Risks,” MOIAFarmLaw.com, http://moiafarmlaw.com/262.
8. Minn. Stat. Ann. § 507.235.
9. La. Stat. Ann. § 9:2943.
10. ORC Ann. 5301.01.
11. See Ed Cox, “Land Contracts for Farmland: Advantages and Risks,” MOIAFarmLaw.com, http://moiafarmlaw.com/262.
12. See National Sustainable Agriculture Coalition, “Land Contract Guarantee Program,” http://sustainableagriculture.net/publications/grassrootsguide/farming-opportunities/contract-land-sales/.
13. For example, in 1979, the Kentucky Supreme Court invalidated a forfeiture clause in an installment contract, treating it as a conventional mortgage. The buyer was given the option to redeem himself or recover his past payments. Additionally, the seller was required to hold a foreclosure sale and provide the defaulting buyer with surplus sale proceeds. Sebastian v. Floyd, 585 S.W.2d 381, 1979 Ky. LEXIS 271 (Ky. 1979).
14. In Ohio, a seller cannot evict a defaulting contract for deed buyer who has been making payments for 5 years or has paid 20% of their total sale price (which includes the down payment). The seller must go through the longer process of foreclosure and a judicial sale. Ohio Stat. Ann. § 5313.07 (Proceeding for foreclosure and judicial sale). See also The Ohio Real Estate Law Blog, “Land Installment Contracts: An Overview” at http://www.ohiorelaw.com/2014/03/land-installment-contracts-overview.html.
The Center for Agriculture and Food Systems is an initiative of Vermont Law School, and this toolkit provides general legal information for educational purposes only. It is not meant to substitute, and should not be relied upon, for legal advice. Each farmer’s circumstances are unique, state laws vary, and the information contained herein is specific to the time of publication. Accordingly, for legal advice, please consult an attorney licensed in your state.