What Is a Lease to Own Mortgage?
In a difficult economy, rent-to-own mortgages are an attractive option for people who want to begin to work towards purchasing a home, but who can not make the purchase immediately. Potential buyers should research this option before entering an agreement to ensure that their situation is right for a rent-to-own.
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Function
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A lease-to-own mortgage is a combination of a rental agreement and a mortgage. A buyer and seller enter into a rental agreement in which the renter has the option to purchase the property within a certain time period at a specified price. The buyer pays the owner a small percentage of the price of the property, usually between one and five percent, in exchange for the option to buy. During the option period, the prospective buyer makes monthly payments. Part of the payment is rent that is determined by market prices in the area. The remainder goes toward the purchase price of the house. If the buyer chooses not to buy, the seller keeps the option fee and the money that has accumulated toward the purchase price. Sometimes, a lender acts as a middleman by taking on the mortgage and working out a lease-to-buy agreement with a buyer.
Regulation
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The Association of Progressive Rental Organizations is the trade organization for rent-to-own lenders. The organization was founded in 1980. It advocates the use of rent-to-own mortgages in legislatures nationwide. Forty-seven states, Guam and Puerto Rico have enacted laws regulating rent-to-own mortgages. New Jersey, North Carolina and Wisconsin do not have rent-to-own laws.
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Risks
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Participants in a lease-to-own mortgage are subject to certain risks. One that is inherent to any contract is credit risk: each party faces the risk that the other will break the contract. Another is interest rate risk. If the interest rate goes up, then the opportunity cost that the buyer incurs by paying part of the purchase price early increases, making the terms worse for the buyer. A third risk is the housing market risk. Since the price is decided at the beginning of the period, the market price of the house can go up or down before the actual purchase.
Benefits
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Lease-to-buy mortgages enable buyers to start working toward purchasing a home if they can not make a down payment. In those agreements that are negotiated by lenders, buyers who can not qualify for a mortgage can get one by proxy. Then, they can work on their credit scores so that they can finance their eventual home purchase.
Disadvantages
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Some potential buyers find that, at the end of their option period, they cannot purchase the home. In some cases, they do not have the credit score to finance the remaining purchase price. In other cases, they may choose not to buy because the purchase price is much higher than the current market value. In either situation, the buyer loses the initial option premium and all of the monthly payments that he has made toward the purchase price. Also, the price in the contract is often high because the rent-to-own market is attractive to buyers who have few other options as a result of bad credit.
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