The new mortgage rules may have some borrowers exploring home ownership alternatives, one being a “rent-to-own” option. You may have heard about doing a rent-to-own for furniture, appliances or electronics, well, it applies to home ownership too. It’s not too common, so I believe it’s important to be well informed before you enter into any type of rent-to-own agreement.
As a mortgage professional, we are usually not involved in a rent-to-own transaction until the buyer is actually ready to purchase the house they have been renting-to-own for say the last 2-3 years. A big difference between a rent-to-own contract and a regular purchase contract is the majority of the downpayment after an initial deposit has been made will accumulate in someone else’s account over the term of the contract. The amount of this payment going towards the downpayment must be in addition to the “market” rent you will pay to live in the home for the contract period. This option is ideal for investors as a revenue property strategy and for buyers who are unable to qualify for a mortgage right away. There are risks that accompany a rent-to-own contract for both the seller and the buyer and we suggest you continue reading for what you need to know about rent-to-own contracts from a mortgage professionals’ perspective.
Let’s start with the basics;
What is a rent-to-own contract and how does it work? A rent-to-own contract or sometimes called an ‘agreement-to-purchase’ is where renters pay market rent each month to live in a specific property; and at the end of a set period of time which is usually 2-3 years, they have the option to buy that property. The buyer and the seller/owner usually agree on a purchase price at the time they write the original rental/purchase agreement. If this is your first real estate transaction, I strongly suggest you have a lawyer review the purchase/rental contract before you sign so you know exactly what you are getting yourself into.
In addition to the monthly rent to be paid, the seller/owner may collect an extra amount with each payment to go towards your downpayment for when you “close” on the property and require a mortgage at the end of the contract period. The seller/owner will likely request an initial deposit at the time you enter into the rent-to-own contract and we suggest you inquire if either your initial deposit or the monthly amount going towards downpayment is refundable in the event you don’t proceed with the purchase at the end of the contract term.
Advantages of a rent-to-own agreement:
- If you are a buyer who can’t qualify for a mortgage right now, rent-to-own allows you to move into the house now and buy later. This gives you time to fix your credit, accumulate your downpayment, or do whatever else you need to do in order to qualify for a mortgage at some time in the future.
- If you are a seller who can’t sell your property as quickly as you want, a rent-to-own contract could eliminate having 2 mortgage payments as your renters will be covering your monthly mortgage payment on the property.
Disadvantages of a rent-to-own agreement:
- Often, the purchase price is set at the beginning of the contract period, even if housing prices rise or fall during that period of time.
- All of those repairs that used to be somebody else’s problem for a rented property often become the responsibility of yours, the new buyer, even during the rental period.
- Some rent-to-own contracts are not suitable to a mortgage lender. The agreement must clearly outline the purchase price, initial deposit amount, monthly rental amount and additional amount going towards the downpayment. It must also include a clause on whether or not any of those amounts are refundable should the contract not be honoured for one reason or another.
- As you are required to qualify for the mortgage at the time you buy, there could be problems with being approved if interest rates are significantly higher or if there have been any changes in the mortgage rules since the time you originally entered into the contract.
- Know and understand what you are getting into before signing! Make sure the seller is educated on the process both of you need to follow in order for you to eventually qualify for a mortgage at the end of the contract period. Again, we do suggest you contact a mortgage professional that can explain what is required by both the lender and the mortgage insurance companies as rules and guidelines seem to be changing quite frequently lately.
- Make sure the purchase price you are agreeing to will be in your price range when it comes time to close and check around to ensure you are paying fair market value for the property.
- Ensure the rental amount you will be paying, not including the extra towards the downpayment credit, is reasonable for the type, condition and location of the property.
- Talk to a mortgage professional prior to selecting a contract term to ensure you can qualify for a mortgage amount sufficient to purchase that home when the contract is due.
Buyer or seller, if you’re thinking of using a rent-to-own as an effective real estate solution, it’s not a bad idea to align yourself with a trusted and experienced mortgage professional. They can help the sellers/owners pre-qualify potential buyers to make sure the contract terms are suited to the buyers borrowing abilities. They can also benefit buyers by guiding them on what they need to do to ensure they can qualify for a mortgage when it comes time to buy the property.
For all your mortgage needs, contact Jackie at 780.433.8412 or email firstname.lastname@example.org. Stay in the loop by following on Twitter @Mortgagegirlca.