Rent-to-Buy Deals are the Order of the Day
These are altogether confusing financial times. If you’re a seller with a house languishing on the market, you might wish you could get rid of the mortgage, rent a place, and get a loan till payday. If you’re a potential buyer, you might be doing something as seemingly contradictory as looking online for a mortgage, a place to rent, and a payday cash advance in Moore all at the same time.
Home buyers are scarce and home financing is tight. Given the current economic vagaries, it’s hardly surprising that rent-to-buy deals are on the upswing. In fact, rent-to-buy deals are so popular right now that if you go to ForSaleByOwner.com, and click on “Advanced Search” you’ll find a special category for “Lease-to-Own” homes.
How renting to buy works
Rent-to-buy deals (or leases with options to buy) typically require buyers to pay option premiums each month on top of regular rent, along with a one-time, upfront, option payment of about three to five percent of the agreed purchase price. At the end of the lease term, if the buyers choose to exercise their option to purchase, the monthly option premiums and one-time option payment are applied to the purchase price.
For example, if the buyers in a rent-to-buy deal agree to purchase a house for $200,000 after renting it for a term, with an option payment of $10,000 up front, and monthly option premiums of $500 in addition to $1000 monthly rent, they will have paid $16,000 of the $200,000 purchase price at the end of one year, or $28,000 at the end of three. If they opt to buy at the end of the lease term, the buyers will finance the remainder of the agreed purchase price.
Advantages
Rent-to-buy deals give buyers the opportunity to experience homes and neighborhoods before making a major commitments. Renting to buy can be a good choice for buyers without money for a down payment who need a place to live now and know they will have money in the near future.
When real estate values are on the rise, buyers may try to negotiate rent-to-buy deals in order to lock in favorable prices. But in today’s declining market, buyers are choosing rent-to-buy deals in order to build up down payments and improve their credit profiles so that they can more easily obtain a mortgage at the end of the lease term.
For home owners trying to sell in today’s market, rent-to-buy deals provide a way to offset mortgage costs. This is especially true for sellers who have purchased new homes but have been unable to sell their old ones, and are now stuck with mortgages on two properties.
Risks
Defaulting on the lease
Depending on the terms of the agreement, buyers may lose any upfront fees and premiums already paid if they default on the lease and are evicted.
Inability to obtain satisfactory financing
Depending on the terms of the agreement, buyers may lose any upfront fees and premiums already paid if they can’t qualify for a mortgage at the end of the term, or if circumstances change and they decide not to buy for any reason.
Falling home prices
In a declining market, the house may be worth less when it’s time to buy than it was at the commencement of the lease term. When that happens, sellers will sometimes agree to a reduced price when it’s time to buy. But if they don’t, it may be less expensive for the buyers to forfeit their investment and walk away from the deal rather than close on the sale.
Foreclosure
When foreclosure rates are high, the buyers run the risk of the sellers defaulting on their mortgage. If the sellers’ bank forecloses, the buyers can be evicted. The buyers might have the right to recover option payments from the sellers, eventually. But if they want to purchase the home, they may only be able to do so if the bank agrees and if they can qualify immediately for satisfactory financing.
Affordability
Even when the buyers are able to obtain a satisfactory mortgage with an affordable interest rate at the end of the lease term, other costs — private mortgage insurance, property taxes, all the utility and routine maintenance costs — can make the property much more expensive to own than it was to rent.
Before you agree to a lease-option deal
Whether you’re a tenant-buyer or a landlord-seller, take the same precautions you would if you were entering into an outright purchase and sale. Get a title report, an appraisal, and a home inspection. And don’t agree to anything without first getting legal advice.
