There's a lot of interest from consumers about lease-to-own arrangements, sometimes called lease option financing. It's sold to consumers as an alternative method to build equity and delays a formal mortgage application for a set period of time, usually 12 to 24 months.
Prospective purchasers with less than perfect credit, no downpayment, and/or high debt to income ratios are allowed to rent a property for the contracted period, usually at a higher price than market values. A portion of this higher rent goes towards the ultimate purchase price, which is often higher than market value, too. Then there's the up-front 'option fee' which can range from hundreds to even thousands of dollars. Many would-be purchasers borrow this money from family. The option fee is refundable in very limited circumstances at best, and sometimes not at all. At a prescribed point in time, the renters are expected to apply for a mortgage and buy the property at the pre-established price.
What a deal for the landlord/seller! They usually dump all of the maintenance of the property onto the renter which helps them maximize their return. Of course, this type of renter is also more motivated to make payments on-time. Some contracts even have fine print that calls for loss of the option fee for being late with a payment by even one day.
Not all investors participating in lease-to-own arrangements are shady. But the rental market has been a bit soft, not unlike the general housing market, and it's getting harder for landlords to attract quality tenants at the prices they need to make a property cash flow in the positive. Like owning the house in which you live, there's overhead to rental properties. Every month that a property is not producing rent is like a boat anchor for the owner.
Most of the time, lease-to-own sounds attractive to first-time home buyers, who are generally not knowledgeable or sophisticated in Real Estate matters. In fact, one nationally known investor who sells his 'system' to other investors claims that around 50% of his lease option tenants are unable to exercise their option to purchase. So they're thousands of dollars poorer than they would have been if they had simply rented at market price! No problem for the investor, though, he just finds another 'buyer'.
Here are a few guidelines for consumers to follow.
- First, if your credit is poor, talk to a credit counselor before doing anything. If you're not able to raise your credit scores enough to qualify for a loan by the time stated in the contract - don't sign it! If your credit is really bad, forget this arrangement totally.
- Watch out for pre-set purchase prices. The housing market is still dropping in values and you may be overpaying by many thousands of dollars when the contract matures. Don't allow the seller to hire the appraiser if the contract calls for that method to determine the sales price. That should be done by either you or your lender.
- Don't let the seller push you to a certain lender, either. There's too much predatory lending that still happens and if you can't get a loan through an established lender who is not affiliated with the seller that's a huge warning signal.
- Make sure that the seller has clear title to the property. There are a lot of people getting 'rights' to market or sell property that they do not own.
- Sign nothing without having it reviewed by an attorney, preferably an experience attorney that specializes in Real Estate Law. The few hundred dollars you spend there can save you a world of suffering, and a lot of lost money, later.
When you deal with Realtors(R) who are licensed by the State, they must adhere to the Real Estate laws as well as their profession's Code of Ethics. Investors have no such formal code and are guided by only their own moral compass. Buyers can have a Real Estate Professional represent them and watch out for their best interests, in most cases for free. If the time isn't right to buy now, work out a plan to get you to that goal by reducing debt, saving money and improving your credit scores.
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