Land contracts for farmland, in which a farm is sold by an owner in exchange for payments over a set period of time, appear to once again be gaining popularity with beginning farmers. Purchasing farmland with an installment contract can be beneficial for farmers with poor or no credit, but it also comes with risks that should be evaluated and for which planning is essential.
Land contracts, commonly called installment land contracts, contracts for deed, or land sale contracts, are real estate transactions where the buyer, or vendee, makes a down payment followed by periodic payments and the seller, or vendor, retains title to the property until all of the payments have been made. These are also sometimes referred to as owner-financed real estate sales.
The buyer is considered to have equitable title in the land while making payments. This means the buyer has the right of possession and use of the property as well as the right to exclude others from the land. It is important to note, that these rights can be limited or altered according to the provisions of the contract. Along with the benefits of possessing and using the land the buyer also accepts the responsibilities of land ownership, including paying taxes, maintaining insurance, and making repairs. Once the final payment is made, the seller provides the buyer with legal title to the property by turning over a deed to the buyer.
The use of installment land contracts has decreased over the last few decades, but it does continue to hold appeal for certain operator demographics, particularly those lacking large amounts of capital and access to financing from lending institutions. It is imperative that landowners and farmers understand the advantages, risks, and legal consequences of using installment contracts.
The primary advantage for a buyer is purchasing land for which they might otherwise not be able to acquire financing. This is made possible by:
lower or no down payments,
lower closing costs as banks and realtors may not be involved, and
a lack of formal applications and underwriting processes
These advantages may be particularly important to farmers involved in niche markets, direct marketing, and value added agriculture as some lenders may not have underwriting procedures for such farm businesses. Further, farmers may be able to take advantage of these opportunities from landowners and angel investors that are concerned less about getting a return than supporting a beginning farmer or sustainable agricultural practices.
There are also advantages for the seller, including:
steady income for the duration of the contract,
interest earned on the financing, and
distribution of tax liability over several years.
Remember, the seller also retains legal title to the property, which provides security in case the buyer defaults on the land contract.
The primary risk for buyers is forfeiture. This results in the loss of the property along with any equity and improvements made to the land and buildings. This can have a devastating effect on any buyer, but particularly those who have significant equity and labor in the land and facilities.
There are legal protections against forfeiture, but these vary greatly from one state to the next. Most states have a mandatory grace period. Iowa requires sellers 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.
The parties to the contract are free to agree to terms as they see fit. Thus, even if not required by state law, the contract can require a grace period, a foreclosure process, or other safeguard.
Farmers can also mitigate losses due to a forfeiture by requiring reimbursement for the non-depreciated value of attached improvements. Sellers, in turn, will likely want to include provisions requiring permission before improvements, for which they may be obligated to provide reimbursement, can be constructed. Contract terms can also provide clarification of ownership and the right to remove more mobile improvements, such as hoop houses.
The principal risk for the seller is that the buyer may not pay. Landowners may be particularly worried about this risk in relation to beginning farmers. However, as discussed above, sellers often have the remedy of forfeiture, a very powerful tool that greatly reduces a seller’s risk. Where forfeiture is not available the USDA Guarantee Incentive program discussed below may be particularly beneficial.
Its important to note, the right of forfeiture does not completely reduce a seller’s risk and can actually create a loss for the seller as well. For instance, in the 1980s many retired farmers that sold land on contract just prior to the farm crisis, were stuck without income because their buyers couldn’t pay and, after forfeiture, owning land with drastically reduced market value. These circumstances are rare but still worth consideration. Again, the USDA Guarantee Program may be helpful in such situations.
As a contract the buyer and seller are, in large part, free to establish the rights and obligations of each party within the terms of the agreement itself.
Typical provisions require the buyer to make specified payment amounts at particular times or intervals, to pay taxes and assessments, and to maintain insurance on the premises. The seller is required to convey the property to the buyer, usually through a warranty deed, and to provide an abstract showing good title at the time of contract formation.
A principal feature of land contracts, the forfeiture clause allows the seller to terminate the contract, regain possession, and retain the buyer’s prior payments if the seller defaults on the contract. This clause and other terms relating to default are discussed further in “The Risks” section.
A due on sale clause requires payment in full if the buyer sells their interest in the property. If financing is unavailable to fulfill this term, a beginning farmer’s ability to cut their losses if unsuccessful is limited.
This clause is common if sellers are using the contract payments as retirement income. This limits a farmer’s opportunity to decrease the total interest they will pay.
There are many other provisions that can play a critical role in the agreement depending on specific circumstances. An licensed attorney in the state in which the land is situated should be contacted for advice.
There are programs that encourage landowners to sell land to beginning farmers on contract. These programs exist at the state and federal level.
Aggie Bond programs are a state-federal partnership providing landowners with a federal tax exemption for interest earned on land contract payments. Iowa and Missouri also exempt interest from state income taxes.
The USDA Farm Service Agency offers a Land Contract Guarantee Program with two options for landowners. First, is the “prompt payment guarantee.” This guarantee covers up to the amount of three amortized annual installments or three annual installments plus the cost of any related real estate taxes and insurance. Second, the “standard guarantee plan” covers an amount equal to 90 percent of the outstanding principal of the loan. More information can be obtained from Local USDA Service Centers.