Rent to Own: Do It The Right Way
Rent to own It’s a goal that can take years of scrimping and saving to squirrel away a down payment — not to mention the careful spending and meticulous bill-paying required to keep your credit score high.
In the meantime, you’re still paying rent, maybe even more each month than you’d pay for a mortgage payment. But what if a portion of your rent were going toward purchasing your rental home at a later date?
That’s exactly the dream that rent-to-own deals are selling, but what’s the catch with rent-to-own homes?
Unlike standard mortgage loans, there isn’t a balloon payment that begins rising immediately. The payments continue to the end of the loan term, but only after that do the principal and interest payments begin.
Fees, on the other hand, come with rent-to-own mortgages. A mortgage insurance premium (MIP) of up to 3.5 percent can be added to the loan amount, while the cash-out portion at the end of the loan is interest-only. Fees aren’t typically considered income by the IRS, so they don’t affect the amount of money you can loan out.
The biggest caveats with rent-to-own deals relative to expenses are the initial down payment required. Many owners are accepting $20,000 or less from borrowers. That may seem reasonable, especially for first-time homeowners, but those requiring a much larger down payment will likely have to save up for renovation costs before they can even begin looking at properties.
Homes are Sold Out
There are also a few other tradeoffs to assess when considering rent-to-own homes.
1. Extra monthly payment.
Many traditional, conventional mortgages require monthly payments ranging from 3.5 percent to 7 percent of the total loan amount. Rent-to-own homes operate differently. Most current homeowners are willing to roll the cost of their monthly homeowner’s insurance and HOA fee into the rent in order to start renting.
The potential extra charge on rent is kept to an absolute minimum through renter’s insurance coverage. If the tenant’s home was destroyed by a fire or other claim, the renter has to carry their homeowner’s insurance policies until the homes are fully replaced.
2. Investor requirements.
As a result of the above types of requirements, buyers looking to purchase a rent-to-own home will often do a walk through with a larger group of potential investors.
With double digit interest rates, an eventual 2 percent exit rate, and affordable monthly payments, potential investors looking to purchase these types of homes are more likely to be able to stomach the extra expense and added risk.
3. More options for owner financing.
For buyers, this means more options for they can turn to as they look to refinance or sell their home. Owner financing is a mortgage method that allows real estate investors to finance a piece of real estate and receive monthly payments each month, as opposed to just a loan payment from a bank.
You already know there are fees and closing costs, so where do the fees come from?
Here is the breakdown of what you can expect when you begin funding your home in order to own it later — as opposed to the more common strategy of renting before buying — subject to your credit score and loan terms.
Rent-to-Own: Fees and Concessions
After scrutinizing your credit and rental history with your lender, the lender will submit your application for a mortgage of $300,000 on a property similar to what you currently own.
If this loan does not work out for whatever reason, you can either sell the home later or refinance and continue renting it, borrowing against that equity in the property and selling it if your plan changes later.
Switching the strategy means you’ll usually be buying a different property down the road. The initial purchase price of your home does not include your rent, security deposit, closing costs, or commissions.
Also, remember that once you put down a portion of the total purchase price needed for the property, you cannot go back later and get out of that mortgage.
Typical fees and costs for a real estate agent and closing attorney for a rent-to-own mortgage include:
Title insurance: $80
Lawn service: $40
Rehab inspection: $75
Mortgage broker: $10
Mortgage Commissioner: $50
Appraisal Claims Representative: $75
Rehab Estimate: $600
Mortgage protection: $150
Lender if you get refinanced: $310
The Fine Print
This is where things get dicey. A rent-to-own is an agreement among a borrower (you) and a servicer (the company you use to manage your property) that offers the borrower the option to purchase the property themselves. At the end of the term, the borrower must pay the servicer that collected their rent for that particular rental home and presumably has their copyright and a lien on it, just like they would have for a typical mortgage.
So what isn’t there to love about this agreement — aside from the fact that the borrower could at any time cancel the contract and potentially lose a home they have paid a total of thousands of dollars toward?
Here’s the “catch.”
For one, when the borrower chooses to buy the house themselves, that opens the door for fraud. Because the borrower is legally persona non grata in the eyes of the bank and will likely have a difficult time getting traditional bank loans ever again (if ever), you may need to- hire an agent to help you with the process.
You have until then to get a buyer into the property — after you’ve re-rented it yourself and after you’ve collected all of the homeowner’s property taxes and hazard insurance.
The whole process repeats itself the following year, every year, and by law — all over again.
But hey, if it works for the borrowers, it’s probably worth trying.