Rent-to-Own (or Lease-to-Own) Real Estate Deals – Buyer and Seller Beware
by Clayton Clossonon July 13, 2007 in Home Buying (still as true today)
Although they’ve actually been around for decades, rent-to-own contracts that substitute for mortgages and conventional home loans are enjoying a surge in popularity in several regions of the country. The slumping real estate markets in parts of the U.S. fuels these deals, where homes can sit on the selling block for months at a time.
Add to this the recent tightening of rules and regulations for bad credit loans and a near perfect storm has been created for rent-to-own scenarios. It sounds like a great way for home sellers to speed up the sale of their home.
Think of it this way: Lots of folks with bad or bruised credit simply can’t qualify for a home loan under current guidelines. So, instead of just renting a place to live, they opt for non-traditional arrangements to buy a home. These arrangements are contracts between the buyer and seller and don’t involve a bank or mortgage company. One of the most common rent-to-own contracts is the land contract.
A land contract is essentially an agreement between the buyer and seller where the seller “finances” the buyer to purchase the home. A payment schedule (monthly amount multiplied by the number of months) is agreed upon, and the buyer pays a down payment as a security deposit to the seller. The title of the home remains with the seller until the buyer has made all the payments. The payment schedule usually covers only a part of the sale price of the home, which means that at the end of the payment schedule, an outstanding balance remains. This is usually paid using what’s called a balloon payment. So, the buyer pays payments for a set period of time, and then must pay the remaining amount to buy the home. For example, the buyer may pay $800 a month for 10 years and have a balloon payment of $50,000 due at the end of the 10-year contract.
Here is the risk: Land contracts aren’t always publicly documented and recorded; rarely a good idea when dealing with real estate and this much cash at risk. Another common rent-to-own scenario is renting or leasing with the option to buy. Such options are different from land contracts in that the agreement is usually filed and is a legal arrangement. They give the renter or lessee the option to buy the property at a set time during the loan. With an option, rent payments become equity in the property.
While the benefits of rent-to-own arrangements may seem strong, both the buyer and seller need to be aware of problems that can result from poor planning. A few of the most common problems faced with rent-to-own scenarios are:
•Repossession can be difficult if the buyer defaults on payments
•The seller is stuck with any repairs, even if the buyer caused them
•The seller may be responsible for real estate tax and property insurance
•If anything goes wrong, the buyer may lose any money paid, including the deposit
•When the time comes, the buyer may not be able to finance the balloon payment after all (remember, the buyer couldn’t get financing to buy the home in the first place)
The most important factor to remember with rent-to-own is that all terms of the contract or option must be spelled out to the smallest detail to avoid any problems. Who is responsible for repairs to the home? Who is responsible for maintenance? What happens if the buyer misses a payment? When is a late fee added? When is the down payment refundable, or at what point does it become non-refundable? Are pets or roommates allowed? Who is responsible for paying property tax and insurance? These are just a few of the important questions buyers and sellers should consider and work out prior to entering into an agreement.
It’s not hard to see why hiring a lawyer to review a land contract or “option to purchase” agreement is a very good idea. There are so many details and potential issues that need to be covered that it’s almost impossible for people to set these up correctly without professional guidance.
A little painstaking preparation setting up a land contract or option-to-purchase will help prevent a lot of problems down the road. And even with proper legal and real estate guidance, know the risks.
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