How the Rent-to-Own Process Works
Rent-to-own contracts typically last between 2 and 5 years. There will be an upfront options fee, and consumers are required to pay rent each month with a portion going towards the purchase.
A purchase option fee can cost as much as $15,000, but it will go towards your down payment.
How the Rent-to-Own Agreement Works
Let’s say you find a rent-to-own home or apartment that is worth $200,000. Your monthly payment will be about the same as if you were buying it. $1,600 per month. $250 a month goes towards the purchase price. There is also an option fee of $9,000 required to be paid up-front.
Owner financing may be a good idea if you lack the credit to get approved for a mortgage. Although, there may be mortgage programs that you may qualify for. Before you move forward on a rent-to-own property, here are some tips you can use to see if you can get approved for a mortgage now.
Pros and Cons
Lease-Option vs. Lease-Purchase
There are two types of rent-to-own contracts, a lease option, and lease purchase.
A lease-option contract means that the renter has the option to buy the property from the owner, but is not obligated to purchase it. If you choose not to buy the property you can simply walk away at the end of the lease.
In a lease-purchase contract, the renter is expected to buy the home from the owner at some point during the lease. While the owner won’t be able to make you buy the property, they could sue you for damages.
Things to do before signing the contract
Before you sign any seller-financed or rent-to-own agreement, there are a few things you should do to protect yourself.
- Beware of any property which needs repairs.
- Get a home inspection before signing any rent-to-own contract.
- Ask for a copy of a recent, certified home appraisal or pay for your own
- Find information on the property owner or investment company.
- Make sure you can qualify for a loan soon.
- Have a real estate agent or lawyer review the contract
- Negotiate a lower option fee and rent payment
Get a Home Inspection
A home inspection will make sure the property is up to code and without any significant problems. You can get the owner to pay for the repairs before moving in. A home inspection will also let you know of any issues such as foundation, roofing, etc. that will need repairs in the future. Look for a home in excellent shape, or else you will be paying for the repairs once you purchase the home.
Get a Home Appraisal
If the property is being offered for a price above what it appraises for, it will be almost impossible to get a mortgage on it. Lenders do not lend more money on a home than it’s worth. A home appraisal will also be useful in negotiations when it’s time to buy the home.
Do Your Research
Google the owner to see if there is any information about them. Past homebuyers may have made a complaint. It’s important to know what the complaint is about and address it with the owner. Check if the owner has any lawsuits or has ever been foreclosed on. You also need to check if the property itself is free and clear of any tax payments and if the HOA dues are current.
Have a Professional Review the Agreement
Before signing any lease-to-own or land contract, you should consult a real estate attorney or work with a knowledgeable real estate agent. They will help make sure you don’t get screwed in the deal, everything is legal, and the terms are favorable. Many owners will add unfavorable conditions deep in the contract that you could miss.
Negotiate with the Owner
You can negotiate some of the terms in the agreement. The sales price, monthly rent amount, and the amount that goes towards the down payment. Talk to the seller to see if they can work with you on lowering some of the terms.
The option fee is the most important item you should negotiate because it’s non-refundable. If you do not purchase the property for any reason, you will lose a substantial amount of money. Try to get the option fee as low as possible to reduce your risks.
Increase your credit score
While you’re in a rent-to-own home you should be working on improving your credit score so when it comes time to buy the house you get a mortgage with the lowest rates. There are a few things you can do to increase your credit score quickly.
- Pay down your credit card balances.
- Negotiate a pay for delete on collection accounts
- Have someone add you as an authorized user on a credit card
- Dispute negative accounts with the credit bureaus
Beware of any property which needs repairs
If the property requires repairs before moving in, make sure the owner fixes them before signing the agreement. Or add a clause to the contract giving the owner a certain amount of time to fix the problems. Beware of any home or apartment with major repairs the owner is not going to repair.
Where to Find Rent-to-Own Homes
Are You Sure You Don’t Qualify For a Mortgage?
Usually, the reason you’re considering owner-financed homes is that you lack the credit, income, job history, or are self-employed.
Speak to a lender now to see what you need to do to be in a position to qualify in the next year or two. If your income is borderline now, it will probably be even tougher later on with interest rates on the rise.
An FHA loan is a Government-backed mortgage loan. They are very popular because of their flexible qualifying requirements. You will need a minimum 580 credit score to qualify for an FHA Loan. Your chances of being approved increase substantially, and you will need a 3.5% down payment.
- 580 credit score with 3.5% down
- 43%-50% maximum debt-to-income ratio
- Two years of stable employment
- Only available for a primary residence
- 24 month waiting period after a bankruptcy
- 1% of student loan debt added to DTI ratio
Requirements by Mortgage Type
There are several mortgage programs for first-time homebuyers that offer a low down payment and have less strict loan requirements. There are also first-time home buyer mortgage programs and grants available. If you can qualify for a mortgage today, then there is no question that buying is better than a lease-purchase property.
Avoid Deed or Land Contracts with Investment Companies
There are investment companies that offer owner-financed and rent-to-own homes that are financed in-house. It is an installment loan on a home, with no traditional mortgage needed.
These properties are found in low-come areas where many foreclosed homes can be found for dirt cheap.
In a recent report from a national law organizing seller-financed homes, “toxic transactions” were built to fail. There is a substantial amount of rent-to-own homes available for less than $100,000.
Many of which are in horrible condition and are purchased from the Government for as little as $10,000. These types of transactions are predatory in nature.
One investment company is offering these homes on a rent-to-own basis but making the buyer responsible for repairs. These homes turn into a money pit for the consumer.
The Bottom Line
Rent-to-own homes come with a significant risk to buyers. If the owner of the property gets foreclosed on, you’re going to be forced to leave.
The contract with be forfeited, and you’ll have to buy the home from the bank.
You may be able to get approved for a home even with bad credit. It’s a good idea to explore all your financing options before moving forward with an owner-financed property.