Thursday, February 25, 2021 / by Sam Gerardi
Options to purchase a home outside of getting financing today exist for about the same reasons. The home seeker does not have the resources to buy a home at this time. It could be a credit problem from bankruptcy or foreclosure, divorce, job loss, medical hardship, new career, starting a business, 1st time home buyer and even no credit at all.
The bottom line: You cannot buy right now, but you want a certain home or area, you don't want to rent and you don't want to move twice.
Like 96% of the buying public, you go online and search, dream and look for options to get what you want. Getting into a home is no different except that you may be pressed for somewhere to live (quickly) depending on your circumstances. So, you read about lease options & land contracts as a way to get into a home. You may even read about so-called no money down schemes (we will address that later!). But you wonder, are they too good to be true. Can you really get the home you want at a price you can afford and finance/re-finance it later when your situation improves.
Simple Answer: Yes, you can. That's the good news. The bad news is it is not without an added cost.
In most cases, the owners of nicer homes in better areas don't want or need to offer terms. These homes sell at fair market value relatively quickly and the risk to the seller typically ends at closing. Sellers often need their proceeds from the sale to move on. Whether buying another home, paying off debt, or investing the sellers would need a good reason to offer terms. And whether you like it or not, sellers typically expect to make money on offer a buyer terms - they become the lender in this case and will be carrying the risk of the buyer's maintenance, negligence and default if something goes wrong. After all, the buyer is the one with credit problems or life circumstances.
Put Yourself in the Sellers Shoes
- Lease option candidates are typically a credit risk or have other life concerns;
- Owners of better homes are not interested in a regular lease/tenant relationship so the buyer must have intention to buy;
- Buyers must have earnest money down – this would become part of their purchase money but it is typically not refundable;
- Maintenance has to be on the tenant/buyer – can the tenant/buyer afford repairs;
- Terms for monthly rent start minimally at interest only payments with a balloon clause to payoff the seller in so many months - this does not go towards purchase price;
- The seller SHOULD want additional monthly payment as an incentive to complete the purchase - this extra money reduce down payment upon purchase, but is not refundable; and
- The best deal for both parties is to include an incentive clause that rewards the buyer for closing prior to a deadline.
EXAMPLE: A $200,000 home seller may want 5% down and 8% interest-only payment on a 24 month contract. The seller is offering an incentive of 2x the amount paid monthly above the interest only payment for a payoff on or before 12 months into the contract, 1.5x the amount paid monthly above the interest only payment of payoff before 18 months and 1x the amount paid monthly above the interest only payment for a payoff on or before 24 month contract term. The seller should also have a default clause at 24 months or a defined change in terms that penalizes the tenant/buyer to compel the fulfillment of the contract to withdraw and vacate - forfeiting their rights and moneys. The math here is pretty simple -
$10,000 Down, $1520/mo. Add $300/mo for overage and close within 12 months will make your down $15,400 at closing. In buying the home, your new payment will be under $1000 at 4.5%.
The "incentive" to fulfill early serves two purposes especially if the buyer contributes regularly :
1) If the tenant/buyer is serious about buying they should be improving their condition to be a good mortgage loan applicant AND they should be saving money for the purchase; and
2) In paying in what they are "saving" in order to buy the property, they can report to the loan officer that they have additional funds towards purchase outlined by the contract.
The motivated buyer will add as much as they can each month above the required monthly payment as that would increase much faster than savings, go towards reducing their loan liability making them both a better applicant and requesting a smaller loan, and instill confidence with the seller. It should be a win-win.
Buyer Beware of Your Misconceptions!
Too often, I hear agents and buyers asking why the seller needs a down payment or why the buyer needs to include a credit report, bank statements & employment verification. Buyers have been mislead into believing that their credit history does not matter, or sellers should be happy with say 5% interest when the banks are offering ~1-2% on CD savings. The answer is really simple, and you may not like it... more often then not, lease-option & land contract buyers are high risk. Private owners simply cant afford to absorb the possible damages and costs like big lenders can.
The bottom line is that these can be a good situation for all parties when all parties perform. Your local professional Realtor can get you connected to a local title company &/or attorney to establish escrow, hold title &/or quitclaim documents and record liens where necessary.
More Info from BankRate: How Rent To Own Works
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