Owning a home remains a critical part of the American Dream. Homeowners have more stability than renters, and buying a home is often the first step on the path to building wealth. Financing a home can be challenging, though. Here’s how to determine if rent-to-own or a mortgage is best for you.
Buying a home is one of the first steps to building generational wealth. Generational wealth is accumulated assets that can be passed down when a person dies. It’s a critical part of long-term, sustainable wealth, and for many people it begins with buying their first home.
In this lifetime, there are other benefits of homeownership that include:
While homeownership is a great way to lay the foundation for wealth-building, there are some instances when renting might be better. If you plan to relocate in under a year, it makes little sense to buy a home. Likewise, if you have just moved to a new city and don’t know which neighborhood is best for you, renting is a good choice while you find your footing.
Rent-to-own is a contract between the homeowner and the buyer that sets aside a certain percentage of rent towards an agreed-upon home purchase price. Under these agreements, the buyer pays a slightly higher-than-average rental price as well as a one-time option fee between 3% and 7% of the total home price. A portion of the rent goes towards the sale of the house when the lease agreement ends.
Rent-to-own is available as a lease-option or lease-purchase.
Rent-to-own is a great way to buy a house after bankruptcy or when you have a ding in your credit.
With this type of financing, you lock in a price at the beginning of the lease. If home values shoot up over the term of your lease, you’ll have more equity when you apply for a mortgage. This can help you to avoid private mortgage insurance (PMI). A portion of your rent is also going toward building equity in the home.
And when it’s time to sign the final closing paperwork, you won’t have the expense and hassle of packing up and moving into your home — you’re already there.
The option fee is nonrefundable. So if something happens and you change your mind, say goodbye to that cash.
The rent is higher than the market rate. You’ll need to make sure you can meet that price, as eviction rules for non-payment of rent still apply to rent-to-own situations.
But the biggest challenge for renting-to-own? If you do not qualify for a mortgage at the end of your lease, you’ll walk away with no house. You can ask your landlord to report your timely payments each month, but there are no guarantees.
If you are a seller and aren’t sure how to manage a rent-to-own situation, definitely take the time to set expectations and fair pricing. This includes which portion of the rent is set aside for a down payment.
For sellers who get cold feet, a rent-to-own agreement can be terminated, but it will cost you. Make sure to outline the circumstances under which you can change your mind about selling your house.
Home mortgages are the most traditional path to homeownership. These are obtained from a bank or other private lender specifically to purchase a home. There are five basic types of home mortgage.
Traditional mortgages have some significant advantages. They are more common than other non-traditional ways to finance a home, so you typically have more options available to you. These can be structured in a variety of different ways that suit your budget.
Mortgages can help boost your credit score, making you eligible for lower interest rates on everything from car loans to life insurance.
There are significant tax benefits, too. If you itemize your deductions, then mortgage interest and points paid at the closing can be deducted. There are limits placed on these deductions, so it’s best to consult with a tax professional.
In some cases, your interest rate is tied to your credit. This can be challenging for first-time homebuyers who have not yet built up a good credit rating.
Most mortgages require a 20% down payment to avoid private mortgage insurance (PMI). This monthly addition to the mortgage — plus homeowner’s insurance and money set aside for property taxes — may increase the monthly payment beyond what is comfortable. Some cities offer grants for first-time homeowners. These might help with the down payment and other closing costs.
If you have questions about mortgage payments and other monthly costs, try to find a reputable real estate agent who can address all of your concerns.
If you are attempting to sell your house above market price and aren't finding any buyers, and you don't want to budge, requiring a traditional mortgage may not get your house sold. Although rent-to-own is not for everyone, switching to a rent-to-own deal might help you get the price you want.
If you are requiring a mortgage, be prepared for last-minute problems if the potential buyer's funding is denied due to poor credit.
Whether you rent-to-own or choose a mortgage, if you are a first-time home buyer, you’re bound to have questions. Make sure you do as much research as possible before choosing the path that’s best for you.
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