Buyers and sellers alike are both looking closer at Lease To Own options, in which potential homeowners commit to a lease with a future option to buy the property. This is an option to look at as loans are getting more difficult for some buyers especially those with less than stellar credit.
This option can be a win-win for both the buyer and seller. If the seller cannot outright sell the home in a timely manner they can at least obtain income while renting the home out to the potential buyer and if they do not buy or default on their payments the owner can evict them. The buyer can have a home option locked in place until they are ready to obtain a loan. If they decide not to buy the home they can walk.
Here's how it works: Instead of outright purchasing a property, a potential buyer draws up a contract with a seller in which the monthly rental payments, based on the home's value and often above going mortgage rates, count toward an eventual sale. All rental payments made pay down the principle if the renter decides to exercise the pre-paid option--typically 1% of the sale price--to buy.
The date at which the agreement expires varies by contract but is typically between one to three years. At that point, the renter can choose to buy the home at the original listed price minus the equity he or she has built. If not, then the homeowner has the option to evict them and keep all payments.
Why would a seller agree to such an arrangement? Well, it's not easy to sell a home these days in many markets. Instead of letting a home sit empty, sellers are often looking for any income stream they can tap. Mix in the tight credit market that makes it difficult for anyone still thinking of buying to do so, and it's easy to understand why this particular brand of transaction is becoming more popular again.
Of course, there can be pitfalls. If a renter eventually decides not to buy, not only do his rental payments disappear, but the premium option fee he has paid for the right to buy also evaporates. Also, if the price of the home goes down considerably over the rental period, then the renter has been paying a rate based on that amount and may find himself overcharged.
On top of that, many contracts in lease to own situations disallow late rental payments from counting toward an eventual sale. Those people with punctuality problems might lose equity.
It can be complicated and renters should be careful about the terms of their contract, especially elements that allow the seller to terminate the arrangement, such as maintenance of the property, payment times or individual clauses. If the housing market improves and the seller can get more at market than in the renter's option deal, the seller may want to renege.
"Renters who want this option should go with a reputable broker and a good real estate attorney," says Anthony Sanders, finance professor at Arizona State University. "The incentive for the owner to cancel the option if house prices increase quickly is tremendous."
Still, it can be a perfect option for an aspiring homeowner. Credit is tough enough at present, and for those with spotted credit histories it's nearly impossible to get a loan. Those looking to build equity while improving their credit history will find rent-to-own a strong match.
Rent-to-buy should be made as part of a plan to own a home, otherwise it will end up costing more money in fees and above-market rent payments. Make sure the eventual purchase is driving the decision to enter a rent-to-buy.
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Thanks to Matt Woolsey at Forbes for some of the information.