Before the market crash of eight years ago, rent to own loans or owner finance buyers were relatively rare; it was fairly easy for most people to qualify for a conventional or FHA home loan.
The market crash changed all that. Credit standards tightened, people’s credit took a nose dive, and savings accounts were depleted as millions lost their jobs.
Today, it is much easier to get a home loan, but there are still people whose credit scores are too low to secure traditional financing. That is where a rent to own loan can be useful.
Overview of Rent to Own Home Loans
A rent to own contract mandates that the renter and prospective buyer pays rent to the owner each month, and part of it is going towards buying the home later. The contract could last anywhere from two to five years. At that time, both parties will start the home purchase process.
This type of transaction can benefit renters because it means that you will eventually in a few years’ time actually own the home you are in.
It also can benefit sellers if they are having difficulty selling their home at their desired price. They can get the mortgage paid from your renter, and know that in two or five years, you will have the house sold.
On the renter’s side, you need to make sure that when the rental period has expired, you are going to be able to qualify for a traditional mortgage. This means that you need to increase your credit score as quickly as you can if you want a rent to own mortgage with the lowest interest rate.
Pro’s and Con’s of Rent Own Loan Programs
For buyers, you have the ability to try out the neighborhood for a few years, and to build up your credit and down payment.
Also, you can lock in the price, and the terms early one. This could allow you to buy the property under market value in a few years.
Note that the buyer will need to negotiate with the landlord and the mortgage company about how much of your payment goes towards the down payment and closing costs.
You might for example pay a rent of $1,750 per month, and pay an additional $250 per month to buy the home. After three years, you would have $9000 available for down payment and closing costs. That money would be set aside to be used when you go to closing.
However, note that if you decide to not buy the home, you may be out all of that money. Usually, a rent to own contract stipulates that the money only goes back to you if you buy the home.
On the seller side, a benefit of a rent to own contract is that you have a long term tenant who will become a first time home buyer. It is likely that the tenant will take better care of the property than a regular renter.
There is a risk that the renter will decide not to buy the home, but you will be able to take the money that they saved and use it as you see fit.
The seller also could have a disadvantage in that the locked in price could be well below market value in three or five years’ time.
What Should Be In the Contract
Every rent to own contract is different. It is a good idea for buyers and sellers to get advice from a real estate attorney before engaging in this type of contract.
Buyers also should talk to mortgage lenders before they sign a rent to own agreement. It is important to be sure that you will be able to qualify for a loan at the end of the term. Many rent to own agreements have been torpedoed because the buyer cannot qualify for a first time home loan at the end of the rental period. And that money that was put aside normally is forfeited.
Buyers also should get a home appraisal and a home inspection to ensure that they are not buying a lemon. Also, have a title company check the title on the home to make sure there are no problems with it.
Another possibility to consider is to set up an owner finance contract with the home owner. This is where you agree to buy the home from the seller on terms. It is just like getting a rent to own mortgage, but the seller is providing the mortgage lien in this case. This is a good option for people who want to stop paying rent but do not have the credit currently to buy their own home.
An owner financed loan or contract will have a high interest rate of 9% or 10%, but this is a good option for getting into your home own. After you have improved your credit, you then can qualify for a traditional mortgage at a competitive interest rate.
Tips on Rent to Own Home Loan Programs for New House Buyers
People who have had past credit troubles may not be able to qualify for a traditional mortgage. While there are mortgages available today for those who have very low credit – FHA offers loans for people with credit scores in the 500’s – sometimes there are situations where buying a home with a mortgage is not an option for the time being.
In that case, what can you do other than continue to rent? One option to consider is a rent to own home loan. Rent to own homes can help people who have had credit problems, such as a recent foreclosure or bankruptcy. If you understand the advantages and disadvantages of a rent to own home loan, this can be a good way to get into a home.
How a Rent to Own Home Loan Works
In a rent to own home loan, the lender has a mortgage on your home for a certain length of time. You move into the house and pay the lender the rent that is equal to what the mortgage is, and the lender applies the payment to the mortgage. You may pay a certain amount above the cost of the mortgage; this is referred to as your home buying credit. At the end of a two year lease if you put aside $200 per month, you would have $4800 saved up. This money would go back to you at settlement and can be used for closing costs or the down payment.
When the contract is up in one, three or five years usually, you can purchase the home. Some rent to own programs may allow you to assume the mortgage (this can be done with FHA loans, if you qualify). Or, you may need to qualify for your own financing. If you decide to purchase the home, you will enjoy the equity that has built up in the house during the lease period. But if you do not buy the home, the equity stays in the lender’s hands.
The big thing to watch out for is not being able to qualify for a mortgage. Then you can kiss that $200 per month or whatever you paid on top of the mortgage, good bye.
Why Rent to Own?
Rent to own is not for everyone, but it can be a good option for people who have the monthly income to make a mortgage payment but cannot currently qualify for a home loan. Or, you may not have the money right now for a down payment. You normally do not need much for a down payment when you sign up on a rent to own program; some may not require any down payment at all.
Questions to Ask
Most rent to own programs are made to help people with lower incomes or first time home buyers. Thus the income requirements may be lower than for a regular mortgage. Fannie Mae requires you to have a total household income that is at or under the median income for the zip code in which you are buying. Some of these programs are only for people buying their first home; others require that you take a course on buying a home.
Next, how much of a down payment do you need? Some lenders may not want a down payment, but others may want 3%. This also may be referred to as a participation fee.
Another question is how much the closing costs will be and who has to pay them? Some lenders may give you the closing costs and add that to the amount on the loan. If you lack the cash for the closing costs, you should see if your lender will pay for them.
Next, when does your buy option occur? In most cases, the option to buy the home will occur when the rent term is up. Some states may require you to buy the home within a certain number of years.
Also, what are the requirements to qualify for the mortgage? Most lenders will expect you to get your credit score higher so that you can get an approval. You need to very carefully plan to make sure that your credit score is high enough so that you can buy the home.
We want to stress the last point very clearly. What torpedoes many rent to own deals is that the renter is not able to qualify for a mortgage. It takes time, effort and self-discipline to raise your credit score. To make a substantial difference, you should build in at least a year’s time to raise your score significantly. Pay off debt and make all payments on time. The last thing you want is to reach the end of the rental term and not be able to buy.
If you cannot qualify for the loan, you can see if you can renew the lease. If not, you will need to move and you are going to lose any fees that you have paid as well as any equity in the home that has built up.
Some homeowners may want to set up a rent to own program with you on their own. These contracts can be fine, but sometimes they can turn out to be scams. The problem with them is that more often than not, the renter does not qualify for a loan at the end of the term and loses any money they have put into the deal.
Going with a rent to own program with a big lender is generally less risky. If you do decide to do a private rent to own agreement, we recommend that you run the contract by a real estate attorney.
Rent to own home loans can be a good fit for people who have a job and income but lack credit to get a mortgage. The big thing to remember is to make darned sure that you can qualify for the home loan at the end of the rental period. Or you can get stuck out in the cold, out a lot of money.