Consumers with poor credit histories or small down payments will find that loans that were once plentiful are now unavailable. Buyers who are unable to qualify for traditional mortgages will find the concept of lease option (also known as rent-to-own), land contract or seller-financed deals appealing. And the downturn of the real estate market has made sellers more likely to consider these unorthodox deals. Be advised: there's no standard deal, and they're not for everyone.
Rent-to-Own, or Lease Options
In a rent-to-own or lease option deal, the prospective buyer and seller agree on a purchase price in advance. The buyer -- also known as the tenant -- pays an option fee at the outset of the lease, usually between 1 and 5 percent of the purchase price. In addition, the tenant pays above-market rent during the lease term, known as the rent premium. At the end of the term, usually between two and five years, the rent premium and the option fee are credited toward the purchase price of the home. Until the tenant officially becomes the buyer and obtains a traditional mortgage, he does not have an equity stake in the property. If the buyer is unable to perform (meaning, get a mortgage), he forfeits the option fee and the rent premium.
Note that the amount of the option fee and the rent premium are negotiable, as is the amount of the rent premium that is credited toward the home's eventual purchase. During the lease term, the owner is still responsible for property maintenance, taxes, insurance and her own mortgage.
Installment Land Contracts
Installment land contracts differ in that the buyer owns the house, except for the deed, which is held by the owner. The purchase price is agreed upon upfront, and the buyer pays 2 to 10 percent of that price as an upfront fee, in addition to monthly payments, including interest, to the owner. The buyer pays the property taxes and insurance. Buyers are also responsible for property maintenance and repairs. The deal is recorded with the town or county clerk's office, and the buyer has an equity stake in the property.
Deals usually last between two and ten years. At the end of the term, the buyer typically refinances with a traditional lender. Should the buyer not purchase the home, the upfront fee and the payments are refunded by the seller (money the seller recoups upon his own sale of the property).
Still another option is to have the seller self-finance a mortgage. The safest way for a seller to successfully write a mortgage is to require a large down payment, at least 20 percent, and also require excellent credit. Although the seller assumes more risk, she generally does not have to lower her asking price. The closing takes place quickly. In addition, the note may be convertible to cash, and there may be tax advantages, as well.
A buyer who opts for seller-financing may not be able to get a loan at a traditional bank, despite being able to afford it. In addition, buyers also pay lower closing costs, in addition to not having to establish an escrow account or pay mortgage points or fees. Payment schedules may also have increased flexibility.
Doing Your Homework
Both buyers and sellers need to do advance homework in order to successfully consummate a transaction. Buyers should carefully examine their finances to ensure that they will be able to afford a mortgage when the time comes; in a lease option deal, if the buyer can't get a mortgage he may lose thousands of dollars. If necessary, buyers should also use the time to improve their credit scores and save as much money as possible.
Sellers should expect that applicants may have spotty credit histories. Insist that potential buyers complete an application and submit to a credit check.
Both buyers and sellers should invest in an independent appraisal to determine the value of the property, get experienced representation to help negotiate and also consider hiring a handyman or property manager to address maintenance issues. In addition, a basic understanding of each other's financial health helps ensure that a deal is consummated successfully.