Promissory Note vs Land Contract: Which to Use for Seller Financed Land

Transcript of Module 6, lightly edited for readability. The video was recorded before we passed 250 notes; the figures on this page are current.

Welcome to module six. This is one of the most important modules in this entire course. The decision you make here, whether to use a land contract or a promissory note with a deed of trust or mortgage, will determine whether you can easily sell your notes, protect yourself legally, and avoid massive headaches down the road. Let me be very clear from the start.

Always use a promissory note with a deed of trust or mortgage. Don't use land contracts. Let me quickly explain what we're talking about. A land contract, also called a contract for deed, is an agreement where the seller retains legal title of the property until the buyer pays off the entire purchase price.

The buyer gets equitable title and the right to possess the property, but the seller remains the legal owner on the deed until the contract is fully paid. A promissory note with a deed of trust or mortgage works differently. The property immediately deeds to the buyer closing. The buyer becomes the legal owner, but the seller holds a lien on the property through the deed of trust or mortgage, which secures the promissory note.

If the buyer doesn't pay, the seller can foreclose. Now let me explain why the second option is dramatically better.

There are about 10 reasons that I don't like land contracts. Let me walk through the major ones. First, you own the property. With a land contract, you remain the legal owner of the property until it's paid off. This means you're liable for anything that happens on that property. If someone gets hurt on the property, you could be sued. You will need to maintain liability insurance on a property you don't control.

This is a terrible position to be in. Second, they're much harder to sell to note buyers. When you try to sell a land contract to a note buyer like me, it's much more complicated. I not only have to buy the contract from you, I also have to get the property deeded to me, which involves additional paperwork, transfer taxes, and the loss of coverage for the owner's title policy.

Many note buyers won't touch land contracts at all because of these complications. Third, transfer tax issues when the loan is paid off. When the buyer finally pays off a land contract, you have to deed the property to them. In many states, this triggers transfer taxes all over again. So the buyer ends up paying transfer taxes twice.

once when you originally sold it, and again when they finished paying and you deed it to them. This is a totally unnecessary expense. Fourth, complicated and varying state laws. Every state handles land contracts differently, and some states don't even have laws at all for them. Some states treat them more like mortgages. Others treat them like leases.

the legal requirements and processes vary dramatically. What works in one state may not work in another, and this can actually work against you as an investor. Fifth, there's a dangerous misconception. Many people think that if the buyer stops paying on a land contract, you just cancel the contract and resell the property to someone else. This sounds simple.

but it's completely wrong in most states. You typically have to go through a formal legal process to cancel the contract, and in many states, that process looks a lot like foreclosure anyway. Sixth, some states require foreclosure regardless. In certain states, if a buyer has been making payments for a certain period of time, say five years, or if they've paid a certain percentage of the purchase price, say 20%, you have to go through a full foreclosure process to get the property back. You can't just cancel the contract. So you end up with all the hassle and expense of foreclosure anyway, but with the additional complications of a land contract. Seventh, memorandum's cloud title.

In some states, you have to file a memorandum of land contract to protect your interest and the buyer's interest. This memorandum shows up on title and can create issues down the road, especially if there are disputes about the contract terms or if the buyer defaults. Eighth, upset buyers can file liens. If you take the property back from a buyer under a land contract, and that buyer is upset about it, they can file liens or clouds on the title that you then have to litigate to clear before you can resell the property. This creates massive additional legal expenses and delays. These problems aren't theoretical. I've seen every single one of them happen to investors who thought land contracts were simpler. They're not simpler.

They're more complicated and more risky. Now let me explain why using a promissory note with a deed of trust or mortgage solves all these problems. First, the property deeds to the buyer closing. This means clean title transfer right away. The buyer is the legal owner and you're not liable for what happens on the property because you don't own it anymore.

Second, you have a clear foreclosure process in all states. Every state has a well-established procedure for foreclosing on mortgages and deeds of trust. The law is clear, the process is predictable, and attorneys know how to handle it. There's no ambiguity about what you need to do if the buyer stops paying. Third, you have better legal protections. Mortgages and deeds of trust have been around for centuries.

The law is clear and well developed. You have strong protections as a lender. Fourth, it's much more attractive to note buyers. When I evaluate whether to buy a note, I strongly prefer notes secured by deeds of trust or mortgages. They're cleaner, easier to understand, and easier to foreclose if necessary. I'll pay much more for a note with a mortgage than I will for a land contract, if I buy the land contract at all.

Fifth, buyers prefer owning the property immediately. Most buyers want to own the property, not just have a contract to purchase it someday. When you tell them the property will deed to them at closing, they're more excited about the transaction. Six, no ongoing liability for you. Once you close and the property deeds to the buyer, you're done with the property ownership. You hold a lien, but you're not the owner.

You don't need liability insurance. You're not responsible for property taxes or maintenance. It's clean. The bottom line is this. Notes and mortgages are simpler, cleaner, better protected legally, and much more marketable if you want to sell the note. Let me emphasize this one more time because it's critical. If you want to sell your notes to me or any other note buyer, You need to use promissory notes with deeds of trust or mortgages. I have no interest in buying land contracts. They're more work, more risk, and more complicated. I'll pay significantly less for a land contract than I will for a properly structured note and mortgage. If you use land contracts, you're making your notes much harder to sell and much less valuable. You're leaving money on the table. Don't do that.

Use the right legal structure from the start. Remember, always use a promissory note with a deed of trust or mortgage. Never use land contracts. The property should deed to the buyer at closing, and you should hold a lien through the deed of trust or mortgage. This protects you, makes the note more valuable, and creates a clean, simple legal structure.

In the next module, we'll talk about which properties qualify for seller financing and which ones you should avoid. Let's keep going.