There are many ways for both the seller and buyer to both benefit from rent to own homes. Rent to own contracts are not standard purchase contracts. The seller and buyer can write almost any clauses into the contract that meet their needs. Today's real estate market is showing signs of recovery but it would be even stronger if more buyers could qualify for loans.
Back on January 10, 2014, new mortgage underwriting criteria went into affect requiring a debt-to-income ratio of less than 43 percent for most qualified mortgages. The result is fewer potential buyers qualifying for a loan. Under the right conditions, rent to own homes become a good option for both the buyer and the seller.
Rules vary from state to state but you can create a contract allowing lease options that benefit both the seller and the buyer. Typically, a lease option agreement allows the renter to buy the house within a set amount of time but doesn't require him or her to make the purchase. Often the down payment and debt to income ratio are the major obstacles preventing the want-to-be buyer from qualifying for a traditional mortgage.
The lease option agreement can be written so that the renter qualifies for a loan some time in the not to distant future. The lease option can help the tenant/buyer over come the common mortgage stumbling blocks by helping the buyer earn equity in the house. This can be done by charging a higher than market rate of rent and applying a portion of the rent towards the down payment.
If the house is selling for $125,000 and $400 of the rent is applied towards the down payment, it will take about 5 years for the renter to accumulate a 20% down payment. If the lease option fee is applied towards the down payment, needed equity will be in place sooner.
Another option for lease option can include a version of seller financing. This is when the seller carries the mortgage instead of having the buyer qualify with a bank. Since the seller is going to want all of their money sooner rather than later, a balloon payment is included in the contract. The buyer then finances the balloon payment with a traditional mortgage at a future date.
The seller can help the buyer qualify for a traditional loan by reporting timely payments to the credit bureaus. Of course, the buyer needs to stay current with the payments or the seller will foreclose on the house in a seller financing arrangement or evict the tenant in a lease option arrangement that hasn't been converted into a sale.
There are several ways the seller benefits from a rent to own home contract. The first way is that typically the selling price of the homes is about 10% higher than the current market rate. The buyer should accept the higher selling price for a couple of reasons. First, a lease option allows the renter to buy the home but doesn't require him or her to. This means the seller has more risk than in a traditional sale. Second, the house is most likely to be worth more money when the renter converts to a buyer at a future date.
However, rent to own home contracts need to have some built in protections for the renter as well. For instance, the current owner should not be allowed to take out a new mortgage on the property. The renter should also have the title checked to be sure the owner is fully entitled to sell the home.
While rent to own homes contracts are a good tool for both sellers and buyers in today's credit strapped economy, they are not without risk. Both parties to the transaction are best served by having a real estate attorney draw up the rent to own homes contract.