View metadata, citation and similar papers at core.ac.uk brought to you by CORE

provided by Digital Repository @ Iowa State University

Volume 14 | Number 5 Article 6

11-1-1959 or Mortgage? James E. Roan Iowa State University

Marshall Harris Iowa State University

John F. Timmons Iowa State University

Follow this and additional works at: http://lib.dr.iastate.edu/farmscience Part of the Agriculture Commons

Recommended Citation Roan, James E.; Harris, Marshall; and Timmons, John F. (1959) "Land Contract or Mortgage?," Iowa Farm Science: Vol. 14 : No. 5 , Article 6. Available at: http://lib.dr.iastate.edu/farmscience/vol14/iss5/6

This Article is brought to you for free and open access by the Iowa Agricultural and Home Economics Experiment Station Publications at Iowa State University Digital Repository. It has been accepted for inclusion in Iowa Farm Science by an authorized editor of Iowa State University Digital Repository. For more information, please contact [email protected]. ) I \

··············•·•••···········•···••······• •..•.•..•.... • .•.•......

The use of land contracts in buying and selling arms is increa · ·~...:.:inc:..-~ Iowa. The contract is basically different from the traditional and mortgage, and advantages and disadvantages should be weighed carefully.

by James E. Roan, Marshall Harris and John F. Timmons

AND CONTRACTS have terest rate, the repayment sched­ The law doesn't set up require­ L doubled in use during the ule and other factors. These in­ ments as to the amount of the past 10 years in Iowa. One of clude the handling of taxes and down payment under either ar­ every five farms sold in Iowa cur­ insurance, the maintenance of the rangement. rently involves the use of an in­ property and safeguards in case stallment land contract. What are of failure to live up to the agree­ • In case of default by the its advantages and disadvantages ment. buyer, the seller can repossess the as compared with the more tradi­ Yet, the two means of selling farm on 30 days' notice through tional mortgage? What are some land on credit--contract or deed the inexpensive legal process of of the essential elements in devel­ and mortgage-are different. The for/ eiture, if the land contract in­ oping a land contract? People in­ basic differences include: cludes a forfeiture clause. The terested in buying and selling legal processes in case of default • Formal legal to the farms are raising these questions. are much more complicated with farm remains with the seller under This article provides some of the a mortgage, and the time required answers. a land contract, rather than pass­ to foreclose a mortgage is much ing immediately to the buyer as greater. One study shows that the under a deed and mortgage. The The Land Contract time to complete foreclosure pro­ buyer becomes the equitable or ceedings averages about 15 An installment land contract is beneficial owner. The buyer has months in Iowa. The buyer with a sale agreement between the most of the rights of an owner, a mortgage has a year in which buyer and seller of a farm. The and, if he fulfills his part of the to redeem the property and is en­ contract sets forth the rights and agreement, the seller must deliver titled to possession for that year. duties of each. Just as under legal title at some future date. Both land contracts and mort­ a deed and mortgage arrangement, • The seller extends the credit gages are legal-economic agree­ the parties agree on the price, the and gains the interest under a ments. The decisions regarding amount of down payment, the in- contract. Mortgage loans are the amount of the purchase price available from many other to be carried, interest rate, repay­ JAMES E. ROAN formerly was research assistant, Ag ricultural Law C e nter, State Un iversity of Iowa, sources. ment schedule, etc., are economic a nd now is a practicing atto rn ey in Toledo, Iowa. decisions. How much risk to as­ MARSHALL HARRIS is agricul t ura l economist, Farm Economics Research Division, ARS, USDA. • The down payment with a sume likewise is an economic de­ JOHN F. TIMMONS is professor of economics at Iowa State. This article is based partly o n re­ land contract usually is smaller c1s10n. The land contracts or search conducted under regional project N .C. 15. than under a deed and mortgage and mortgages that give ef­ The opinions expressed in this article are those of the authors and do not necessarily represent the arrangement. But this isn't nec­ fect to these decisions are legal views of the Farm Economics Research Division, the AQricultural Research Service or the USDA. essarily so from a legal viewpoint. documents.

15-383 Advantages, cent of the s.i;;:g price. ~ found in our study was 18 Disadvantages taxpayers, par~cularly older ones, percent. will find that t}i~er-all gain AO'reement on the size of the Land contracts have disadvan­ will be taxed below the regular dow~ payment depends on the tages as well as advantages which capital-gains rate when the gain needs of both buyer and seller. If may differ for the buyer and for is spread out. The same tax rules, the seller is interested in the tax the seller of land. These features of course, apply to a deed and advantages of installment selling, of the land contract should be mortgage sale if the payments in the down payment, plus other weighed carefully by both parties the year of sale are low enough. principal payments in the year of to determine whether they're im­ • The main disadvantage to sale, can be no more than 30 per­ portant in each particular situa­ cent of the selling price. The tion. the seller is that the risk of a low down payment may be too great. seller might want enough down • The main advantage of the Although the seller may repossess payment to protect him in case land contract from the buyer's the farm on default by the buyer, of a drop in land prices. The viewpoint is that it enables him the uncertainty in carrying out a buyer might want to pay enough to acquire an ownership interest land sale may lessen the appeal down to keep his interest and in the land through a small down of land contracts to some sellers. principal payments within bounds. paymrnt. A low down payment Neither buyer nor se:Jer should is perfectly legal in a sale with want to deplete the operating cap­ a mortgage. Few sellers of land, Major Items . . . ital of the buyer so much that it however, are willing to accept a will endanger his ability to repay low down payment under a mort­ If you decide that the advan­ the loan. tages of a land contract outweigh gage arrangement. So the land contract usua:Iy is used in cases the disadvantages, there are a of low down payments on farms. number of basic points to consider Actually, no down payment is re­ in deve!oping a land contract. quired by the law under either a mortgage or land contract. Also, What purchase price and in1er­ either instrument may be used if est rate? An initial consideration the down payment is large. is the price of the land and the interest rate on the unpaid bal­ Th,e main disadvantages of the ance. The total cost is the long­ What repayment schedule? land contract for the buyer are: time combination of price and in­ The repayment schedule should • He may lose his equity in terest. Interest on $10,000 at 5 meet the needs of both parties. the farm if the seller regains pos­ percent, for example, is the same The seller may want to keep the session through forfeiture because as on $12,500 at 4 percent. A annual payment low to fit in with of default by the buyer. The lower down payment and a larger his other sources of income. Or, buyer is without the protection of unpaid balance increase the inter­ he may want a substantial annual the mortgage laws for his equity est cost. Income tax considera­ payment to meet current living in the farm. tions, however, may be involved. expenses. Much depends on his The buyer deducts interest, but • He has less time to make up age and other sources of income. his payments after a default than not principal payments. The sell­ The buyer may want to keep with a mortgage. If payment er's gain on the sale may be a his payments low until he's clear long-term capital gain, but the in­ isn't made within 30 days after of debt on all of his machinery notice is given, the seller can terest is ordinary income. and livestock and has accumu­ repossess the farm. lated a cash reserve for current operating expenses. Or, he may The main advantages of the want to make high annual pay­ land contract for the seller are: ments to retire the debt as rap­ idly as possible. • He may have a quick and inexpensive means of repossessing Some sellers prefer a fixed an­ the farm in case of default by the nual payment, with no variations. buyer. Others may be satisfied with a variable annual payment. Some • He may be able to obtain a How much down payment? buyers prefer a variable annual higher price for his land, since The amount of the down pay­ payment related to the wide vari­ more potential buyers may be at­ ment may be arranged to suit ations in their annual income. tracted by the low down pay­ your situation. Some land con­ This can be worked out by mak­ ment. tracts provide for no down pay­ ing it possible for the buyer to • He may spread the federal ment. Such an agreement usually make prepayments in years of income tax on the gain from his is between relatives. Some down high intome. It could also be sale over the period of the con­ payment is made in most cases. agreed that the accumulated pre­ tract, ii the payments in the year Usually it isn't above 30 percent payments over and above the of sale are no more than 30 per- of the purchase price. The aver- base schedule could be used to re-

16-384 duce the required payments when the buyer's review before making any. They'll want to know ex­ income is low. Usually it's pro­ all of the down payment or before actly when the responsibility vided that such prepayments can taking possession · of the farm. shifts from the seller to the b1:1yer be made only in certain amounts These contracts provide further and what will be done in case the - in units of $100, $500 or $1,000 that the abstract is to be brought buyer fails to keep taxes paid. -and at a regular time of pay- up to date just before the final The contract should state the ment. Sometimes a limit is placed settlement is made. taxes and special assessments for on the amount that can be pre­ which the seller is responsib!e. paid in any one year. Reference should be made to the Shift contract to mortgage? year for which the taxes are pay­ Most land contracts provide that able and the year in which they're the seller will transfer the deed payable. (Taxes for 1959, for ex­ to the buyer when the final pay­ amp:e, are payable in 1960.) If ment is due and made. But an in­ the possession date and the end­ creasing number of contracts pro­ ing of the tax year vide that, after a given percent­ don't fall on the same date, the age (usually 40-60 percent) of contract may provide that the the principal has been paid, the taxes will be prorated, based on seller will give the buyer a deed The basic idea is to show proof the fraction of the year that the to the property and receive in that the seller can furnish a mar­ seller held possession. return a mortgage to cover the ketable title before the buyer ac­ For federal income tax pur­ unpaid balance. The previously quires considerable equity in the poses, the deduction for real es­ agreed-upon interest rate and re­ farm. Otherwise, he might make tate taxes in the year of sale is payment schedule can be main­ all payments except the last one divided between buyer and seller tained, and other general condi­ before discovering that the title according to the number of days tions of the agreement can remain has an objectionable "cloud" in the year that each held the unchanged. which, in effect, makes the title property, even though the con­ The switch from a land con­ unmarketable. Thus, the buyer tract provides otherwise. tract to a mortgage would elimi­ shou:d require an acceptable ab­ Special assessments are paid for nate an important remedy of the stract before he invests consider­ improvements to the property. seller in case of default by the able time and money in the farm. The contract should c!early show buyer. The se!ler could no longer whether the assessment is an ad­ use the quick forfeiture provision Taking possession: Transfer of ditional cost to the buver or of the contract. He'd have to title by deed transfers possession, whether it has really been in­ foreclose in case of default. In even though the seller takes back cluded in the purchase price. a mortgage. A buyer under a land other words, he'd be in the same Maintaining property: Keeping position as if the original sale had contract generally isn't entitled the property in good, productive been by transfer of deed and to possession unless the contract condition is also of interest to mortgage. so states. Even though a right of both parties. The se11er's concern When the buyer's equity has possession might be implied in a long-term contract, the agreement arises from the need of keeping become 40 percent or more, he the security (the property) iD may go to a commercial lending should contain a provision that agency and get a mortgage loan the possession of the premises will good condition and undiminished in value for the money that is due to pay off the unpaid balance. shift from the seller to the buyer him. If the land and buildings When this point is reached, it's at a specified date. This provision frequrntly argued that the buyer should also state whether the should deteriorate substantially, the basis for his extension of should nd longer be reauired to buyer or seller is responsible for credit is reduced. This might re­ remain in the unfavorable credit damages or loss to the property position of a land contract pur­ prior to the date of possession sult in his financial loss in case of forfeiture of the contract. The chaser. by the buyer. deterioration could be more rapid, for examp!e, than the buyer's re­ Other Items payment of the principal. Also, the market price might decline, Obtaining abstract: Most despite the upward trend of the land contracts provide that the past 20 years. The buyer should seller has the responsibi:ity of agree in the land contract neither supplying the buyer with a good to commit nor to permit waste to and sufficient abstract of title. COUNTY TREASURER the farm-and to remedy any Some contracts provide that this such waste that may occur if it is title is to be furnished when the called to his attention. last payment is due and the deed Paying taxes and special as­ For specified insurable losses, is to be given. But many of the sessments: Both parties have an the buyer should agree to maintain contracts provide that the ab­ interest in keeping all taxes paid, adequate insurance acceptable to stract will be made available for as well as special assessments, if the seller. This is a common pro-

17-385 vision, and most land contracts This 30-day notice is in sharp buyer's and seller's wills. Because contain such requirements. The contrast with the conventional a land contract changes the na­ problem sometimes is what to do mortgage. The buyer, under a ture of the seller's and buyer's with the proceeds from insurance mortgage, is given a full year­ property interests, for example, it received in case of a loss. Many during which he may redeem the can actually change the distribu­ contracts provide that insurance property after the foreclosure sale. tion of the property under an ex­ proceeds should be divided as the And it may take several months isting will. The land sale must interests of the two parties may from the beginning of foreclosure always be fitted into the whole appear. And this may be all right proceedings to the actual sale of legal picture of each party. in some cases. But for a major the property. A land contract is a legal docu­ loss, such as a barn, you may The seller may use the foreclo­ ment which establishes long-time want to agree that the proceeds sure procedure rather than forf ei­ rights and duties. Buyer and from the insurance will be used ture. But this is seldom done. seller are on opposite sides in the to replace the loss. This may be Foreclosure could be used if the bargain. Sometimes the seller's necessary to preserve the security seller wanted to get a deficiency lawyer drafts the contract, and base for the seller and the pro­ judgment for the difference be­ the buyer accepts it with or with­ ductivity base for the buyer. In tween the foreclosure sale price out minor variations. Each party case the buyer wouldn't want to and the balance due on the debt. should be represented by his own replace the barn or other im­ Foreclosure is more costly, re­ attorney. And each attorney provements, the proceeds might quires more time and provides for should explain to his own client be used to reduce the unpaid prin­ the 1-year period of redemption. what each contract provision cipal. If the contract had no forfeiture means and how the contract af­ clause, however, the seller would fects his other plans and activi­ have to use the foreclosure proc­ ties. ess. The seller could sue for install­ ments past due. This probably would be infrequent. It might be done if the buyer had sufficient money to meet the payment and if the seller had some hope of Failure to fulfill contract: In case one party fails to fulfill his keeping the contract alive with­ part of the agreement, the other out the necessity of suing every time a payment became due. If party has several legal procedures Writing, signing and recording available to secure fulfillment or to the contract provides that, upon the contract: Under Iowa law, all recover losses sustained. He could default of a payment, the whole contracts for the transfer of any sue for damages because of a purchase price becomes due, the interest in land, except for leases breach of the contract, for spe­ seller could sue for the full for a term not exceeding 1 year, cific performance of the contract amount unpaid. must be in writing and signed by or to rescind the contract. Such Transferring interest: Both the the proper parties or their author­ actions aren't frequent, for most seller and buyer may assign, sell, ized agents. difficulties are worked out pri­ lease, mortgage or otherwise dis­ The law doesn't prevent oral vately to the satisfaction of both pose of their interest in the land contracts. It merely withholds parties. or in the contract. Neither party, the legal remedies by which con­ But if the buyer is in default on however, can dispose of a greater tracts might be enforced if they one or more payments, the prob­ interest than he possesses. Neither had been written or otherwise lem is more difficult to solve. The can infringe upon the rights of subject to exacting proof. There­ major remedy available to the the other. Each party's respon­ fore, your land contract should be seller is forfeiture, if the contract sibility under the contract remains put in writing. contains a forfeiture clause. He unchanged unless he agrees to the The land contract should be may, if he chooses, foreclose as if transaction. recorded immediately in the coun­ he held a mortgage. Or, he could The transfer of real property is ty recorder's office. This assures sue for installments past due. too important to be taken lightly. the buyer the advantage of the Let's look into each of these three Land law has many ramifications homestead tax exemption, which remedies of the seller. that may affect every transaction. might be as much as $62.50 each The forfeiture remedy is a spe­ A spouse has dower rights in the year. It may also serve as a pro­ cial feature provided by statute seller's land and in the buyer's in­ tection against transactions be­ for land contracts that contain terest under the contract. Execu­ tween the other party and third forfeiture clauses. The law pro­ tion of a land contract can cut parties. Recording is an adequate vides that if a defaulted payment out the survivor element in a joint notice to the world, so to speak, isn't made within 30 days after tenancy between seller and his of your rights in the land. It formal notice of default, the seller wife. Land contracts raise special also serves as a record in case the can evict the buyer and take pos­ estate-planning problems which original contract is lost or de­ session of the property. may require a re-examination of stroyed.

18-386