Monday, May 23, 2011

Rent to own basics - How does it work?

Rent to own basics - How does it work?

Rent to own homes may be an option, but the choices are very limited.  

Less than 5% of available homes are offered with a rent to own option.

 What Is a Rent-to-Own? A rent-to-own purchase is a lease combined with an option to purchase the property within a specified period, usually 3 years or less, at an agreed-upon price. The borrower pays a down payment fee, usually 3% to 5% of the price, which is credited to the purchase price. The borrower pays rent, and an additional rent premium that is also credited to the purchase price.If the purchase option is not exercised, the buyer loses both the down payment fee and the rent premium.

As with any kind of financial contract, rent-purchase deals can be structured in such a way that all the benefits flow to one of the parties and none to the other. Buyers especially need to be careful.

Contract Features of a RENT to OWN-Purchase
 1. PRICE - The sale price of the house and the rent are market-determined, yet subject to negotiation just as in a straight purchase or rental transaction. Buyers often know less about the market than sellers, which places buyers at a disadvantage unless they do some homework, which is advisable.

2.TIME - Buyers generally prefer a long option period because it provides more time to build equity and repair credit. A long period can boomerang on them, however, if they are never able to exercise the option, since they lose the rent premium they have been paying all the while, in addition to the down payment. Sellers generally prefer a short option period, but if it is too short, the house won’t be sold.

3. DOWN PAYMENT - The down payment and rent premium are viewed differently by buyers and sellers. To the buyer, they are part of the equity in the house they will soon own. Fully anticipating that they will exercise the option, the only cost is the interest they would otherwise have earned. To sellers, however, these payments are the best guarantee that their houses will sell; if they don’t sell, the payments are retained as income. That the benefit to the seller generally exceeds the cost to the buyer makes the rent-to-own deal a possible win-win.

4.OPTION to BUY -  A rent to own purchase also may give the renter/buyer the right to assign the option to buy. This will usually have considerable value to the buyer, because it means that the option can be sold in the event that it has value but the buyer is not able to exercise it. It is a cost to the seller for the same reason.

Using a RENT to OWN-Purchase to Buy
The rent to own purchase offers home ownership opportunities to consumers who can't qualify for a loan from any source, but who are prepared to bet on themselves. The bet is that before the option period expires, they will qualify for the mortgage they need to exercise the purchase option. During the option period, they have the opportunity to rebuild their credit and accumulate equity while living in the house.

Consumers who need to rebuild their credit rating during the option period should understand that paying their rent on time won’t do it. Rent payment information is not used in compiling credit scores. Lease-purchase buyers who need a higher credit score must focus on their credit cards and loans.

A possible alternative to a rent to own/purchase deal for consumers with poor credit and/or no cash is a sub-prime loan. The high-cost sub-prime market, which actively solicited clients and victimized many, was pretty much gone by 2008 but sub-prime loans continue to be available at reasonable prices from community groups or state and local finance agencies. Borrowers have to search out these sources, but if they can qualify for a loan from one, it is probably a better route than a rent to own purchase.

Even though it is costly, the right not to exercise the rent to buy option is of value to buyers. If there is something seriously wrong with the house, neighborhood, or neighbors, the money left behind on a lease-purchase is much smaller than the cost of an outright purchase followed by a quick sale.

Dangers to BUYERS - The contract used in this program made it all too easy for the seller to avoid having to sell when it was more profitable to evict the tenant and do another deal with another hopeful buyer. Buyers generally pay top dollar, perhaps including some assumed future appreciation.

The moral to buyers: read the contract very carefully to make sure you are confident you can live up to all the terms, such as paying your rent on time, every time.

Using a Lease-Purchase to Sell  - Most home sellers want a cash sale, but for those prepared to hang on to the property awhile longer, the benefits can be compelling. Buyers generally pay top dollar, perhaps including some assumed future appreciation. The deal may fall through, but in that case the seller gets to pocket the option fee and rent premium.

The seller also enjoys the tax deduction on his mortgage interest payments during the option period.

A Rent to OWN Scenario
$100,000 home for sale

Remember - The typical rent to own option may require 5% or more as a down payment.  In most cases the deposit is used as a down payment when the final purchase is executed.  On a $100,000 this would be $5000.  Based on the standard rent to own contract, buyer and seller agree to the terms, which include, purchase price, down payment, rent payments, a time limit in which the final purchase must be completed, distribution of the down payment, and other conditions.

Many sellers will require the buyer to be enrolled in a credit repair program if their credit score is below 640.  It is advisable to enroll in a credit repair program as soon as possible.

If the purchase can not be completed within the specified time, the seller may ask the buyer to agree to forfeit the deposit funds.  This is a condition which must be carefully considered.  An automatic extension period may be added to the agreement, contingent upon conditions, such as enrollment in a credit repair program, and additional down payment, and other terms.

The minimum rent amount is usually calculated on the mortgage payment of the purchase price, with an interest rate of 6%, plus taxes, and other expenses.  On a $100,000 home the mortgage amount may be around $600 per month.  The rental amount would be $600 a month plus taxes, usually between $300-$400 per month, plus other expenses.  On a $100,000 home, minimum monthly payments may begin at $900 per month.  The seller may request an additional amount which may be applied to the down payment for the final purchase.

Since the goal of a rent to own property is to obtain a mortgage to purchase the property, the first step is to determine the mortgage amount you will qualify for.  You can contact me for a list of local lenders I have worked with in the Waukesha County and Lake country areas, as well as anywhere in Jefferson, Dodge, Washington or Milwaukee Counties.  You may want to check with the bank you are now doing business with.  A licensed loan officer will be able to tell you how much of a home you can afford, based on your income.  They will also explain your credit score and counsel you on maintaining, or raising your credit score.  If you find out you need to raise your credit score, I can send you a list of lenders offering credit repair services.

Once you meet with a lender, you will have the information you need to move forward on a home purchase.  If you qualify for a mortgage, you may want to consider this option, rather than a rent to own.

There are many loan programs available now tailored to meet your diverse needs. 

 - The USDA Rural Housing loan in Wisconsin is 100% financing available (0% downpayment) in Jefferson and Dodge Counties, as well as other areas of Wisconsin. Waukesha or Milwaukee Counties are not eligible. Further details available upon request.

 - The My Community Loan  designed for first time homebuyers with little or no credit history and little money down. The My community program allows homebuyers to qualify for a mortgage at conforming interest rates and lower pmi premiums. The program's automatic underwriting engine allows for credit scores down to 580. Manual underwriting requires at least 640 credit scores. However, banks may require higher credit scores than posted by Fannie Mae.  My Community Mortgage program requires only 3% down payment. FNMA is also flexible on the source of down payment. It can be the borrower's cash on hand, gift from a relative, or even from the employer.
 Here are some of the program highlights:
- Up to 97% financing
- No prior credit history is required
- No minimum contribution from the buyer’s own funds
- Fixed or adjustable rate loans available with interest-only options
- Loan terms up to 40 years
- Reduced mortgage insurance requirements to help keep payments affordable

 - FHA 203k loan is a loan that allows the buyer to roll in the costs of repairs to rehabilitate the property into the mortgage loan. The formula to do so is quite simple. The bank takes the "as is" market value of the property and adds the costs of repairs to the loan. Upon closing, the repair work is completed and the buyer can take possession of the property.
  • The minimum amount of repairs required to utilize an FHA 203k loan is $5,000 and the maximum is $35,000. However, this is not considered a second mortgage or home equity or improvement loan. This portion of the loan is added on to the primary note.

    These are just some ....of the MANY terrific loan programs available.  

    Contact me for further information, with interest rates so low and inventory high, it at all possible for you.... 
    NOW is the TIME to BUY!

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