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Rent to own OK?

By Peter G. Miller
CTW Features

Question: We pay $1,200 a month for rent and have been considering a rent-to-own program. How much more would we have to pay per month to qualify?

Answer: Rent-to-own programs are designed for buyers that do not have the cash or credit to purchase at this time.  Fannie Mae explains such programs this way:
“Rent credit for option to purchase is an acceptable source of funds toward the down payment or minimum borrower contribution.  Credit for the down payment is determined by calculating the difference between the market rent and the actual rent paid for the last 12 months.  The market rent is determined by the appraiser in the appraisal for the subject property”.

In practice a rent-to-own program might work this way:  The fair market rent for the property is $1,200 a month. The tenant/buyer pays $1,500 a month.  The additional $300 above the fair market rental is a credit to the purchaser.  The sale price is established at the start of the rent-to-own lease, meaning that the price is locked-in.

While such programs may seem attractive in theory, in practice they raise a number of questions:

  • If you’re in a market with strong appreciation, an owner has little reason to enter into a lease/purchase program because the property can be easily sold in the open market.  Also, if the local market is strong, the option price could be significantly higher than the current fair market value.
  • The extra payment – $300 a month in this example- is only a credit if the tenant actually buys the property.  If the tenant does not buy, the money is simply extra rent.
  • At the end of the option period the tenant may not be qualified to purchase.
  • If the tenant misses a single larger monthly payment, they can lose the option and the extra payments.
  • Proper paperwork is a must.  Lenders will want a copy of the rental/purchase agreement, the agreement must be for at least 12 months under Fannie Mae rules, the rent must be at a fair market level as determined by an appraiser and – importantly- buyers must have checks or money order receipts to prove that the rental payments actually were made.
  • At the end of the option period home prices may have declined, meaning that if the option is exercised, the tenant may pay more than the property is worth.  Given that lenders will only finance properties on the basis of their sale price or appraised value, whichever is less, financing can be a problem.
  • The tenants may find another home they like more.

Rather than a rent-to-own agreement, buyers might want to consider a simple alternative: Take the extra payment and stick it into a savings account every month.  Work with a local brokers and lenders and ask if you qualify for any down payment assistance programs- there are more than 2,000 nationwide.  Check your credit report to see if it contains factual errors or items that are out-of-date.  If you find problems, contact the credit-reporting agency to get erroneous material off your report – even small dings can impact credit scores. And, of course, make bill payments in full and on time.

© CTW Features
Peter G. Miller is author of “The Common-Sense Mortgage,” (Kindle 2016). Have a question? Please write to [email protected].