Receive Pro Tips & Insider Knowledge On How To Successfully Build Your Real Estate Empire

Own Home Deals rent to own

How to Structure and Offer Rent To Own Home Deals

Structuring & Offering Lease-To-Own Deals

Future homeowners searching for their next residence will often purchase it with the traditional financing plan of a mortgage and a down payment. But what if you have a prospective buyer who can’t get a mortgage due to their income or credit score? Or what if you are the buyer, and you just don’t want to shell out tens of thousands of dollars in interest payments to the bank? As it turns out, there is still a way to purchase or sell a home without getting the bank involved. How to Structure and Offer Rent-to-Own Home Deals

  • Draft a Purchase Price Agreement
  • Create a Rental Agreement
  • Apply Rent to Principal

That may sound a bit strange to American consumers who have almost universally are taught to believe that down payment and a mortgage is the only way to buy a home.

These types of arrangements typically work like this:

The Traditional Mortgage Method

A homeowner decides they want to sell their home. This seller solicits the services of a real estate agent or REALTOR, who will list the property on the market and manage the general effort to make the home look presentable so it can be shown to prospective buyers. The real estate agent is also responsible for pricing the home reasonably by comparables-similar homes in the neighborhood that have recently sold and that can help establish a pricing point of the residence in question.

Once an interested buyer comes along, the real estate agent will facilitate a discussion about the sale, which will involve negotiation. In many states, a caveat emptor (buyer beware) principle encourages the buyer to pay for a building inspector to examine the property and determine any defects that the seller is not obligated to disclose. Once these have been brought to light, the seller and buyer can work out a purchase price in a purchase price agreement. This is usually accompanied by some earnest money to prove that the buyer is committed to purchasing the property.

The buyer will then begin to apply for a mortgage from a bank or similar lender. This process can take several weeks, as the bank will need to look at the buyer’s income, credit score, and other factors relevant to determining if the lender can safely extend a loan. Part of this process will involve an assessment of the home by the bank’s appraiser. That is because the lender will not issue a loan larger than the value of the property.

If the mortgage is approved, the buyer, seller, real estate agent, and any other pertinent parties (such as lawyers) will meet for closing. The buyer will present the seller with a down payment (often between 10-25 percent of the selling price)– and the bank providing the mortgage will front the rest of the cash, to be paid back over time by the buyer, usually over a 15 or 30 year period of time.

How to Rent-to-Own Homes Work

A rent-to-own arrangement– also called owner financing or seller financing– is entirely different.

Many of the steps outlined above will still be the same, except a real estate agent is not necessary– nor is a bank or lending institution. Instead, the buyer and seller will speak directly and work out a deal themselves. It is beneficial to both parties: the seller has a better chance of obtaining the price they want–and they have some leverage over the buyer. After all, the seller can always walk away from the discussion and wait until a buyer who can get a mortgage comes along–but that type of buyer will have more leverage over the seller because they will be offering a lump sum of money upfront. That means the price of the property could be negotiated lower.

The main feature of this deal is that the home will not be purchased outright–but that the buyer will rent the property from the seller– and their rent will go toward the purchase. This type of arrangement is attractive to buyers who need a more flexible financing plan to purchase a home. There are a variety of reasons buyers may find a rent-to-own home arrangement ideal, though these reasons usually involve difficulty in securing a mortgage due to credit history, income, or other factors.

For example, self-employed individuals may have difficulty securing a mortgage in the tight-fisted lending climate that emerged after the fallout from the subprime mortgage crisis of 2007.

In any case, there is a large degree of flexibility between the buyer and seller in a rent-to-own arrangement. The down payments are often smaller. The interest rate, the term of the mortgage, and the final sale price are also all open to discussion. It is quite an attractive arrangement for homebuyers. One of the reasons it’s not more popular is because it usually only works when the seller owns the property in full.

How to Structure and Offer Rent-to-Own Homes

Though a rent-to-own home arrangement does not involve a mortgage lender or a real estate agent and their closing costs, it still needs to be structured legally to protect all the parties involved.

Purchase Price Agreement

The first piece to the puzzle is creating a purchase price agreement between the buyer and seller.

This agreement establishes the home price and will transition to one of two arrangements: a lease agreement with an option to purchase or a lease agreement with a purchase agreement.

As the names imply, a lease agreement with the option to purchase allows the seller to walk away at the end of the lease. A lease agreement with a purchase agreement creates a legal obligation for the renter to follow through and purchase the home when the lease is up. The seller could even sue for buyer follow-through, if necessary.

In many cases, the buyer will put down option money upfront, which goes toward purchasing the home when the lease term is up. This money is similar to a down payment with a traditional home loan–only in that case, the money transitions to the seller with the immediate sale of the home, and option money might linger throughout the rental period in an escrow account until it is time for the sale.

Though a rent-to-own agreement can be flexible, it’s not uncommon for the arrangement to be short-term. The rent-to-own home purchase price agreement could require an amortized 30-year collection in one lump sum balloon payment after five years.

For example, most property sellers don’t want to deal with the hassle of collecting rent on it for three decades. In many cases, the renter/buyer will be able to secure a mortgage or other loan after this period– since they will have significantly paid down the purchase price of the home. At this point, the rent-to-own agreement would end– and the buyer would start paying toward a traditional mortgage.

Rental Agreement

Next comes the rental agreement. After all, this will be a rental for some time.

In a true rental situation, landlord-tenant roles would be more clear-cut– but when it comes to a rent-to-own arrangement, there is greater flexibility. That could lead to conflict if the terms of the rental aren’t agreed upon beforehand.

A solid rental agreement will define maintenance roles and state who is responsible for fixing what. As this area can become a little gray, it’s not a bad idea to have the agreement drafted by an attorney familiar with real estate asset management.

The monthly rent can be worked out by the two parties involved in the rent-to-own home deal, but guidelines might spell out the market rent in the area or what a monthly mortgage payment might be if the buyer were to get a traditional mortgage loan.

This rental agreement should also specify the lease period of the rent-to-own home. It’s also not a bad idea to reference what will occur at the end of the lease term. That will depend (as mentioned earlier) on whether there is a lease-purchase agreement or lease option agreement in place. The lease option contract or lease-purchase contract should be drafted as a separate contract.

Apply Rent to Principal

When discussing a rent-to-own home agreement, it’s important to discuss how to assign the payment.

Typically, 25-30 percent of the rental payment will go towards the purchase price of the home, while the other amount will essentially be rent. This portion can cover concerns like maintenance costs, property tax, the owner’s mortgage on the property (if applicable), insurance, and interest.

In some cases, a seller may be able to use a rent-to-own arrangement as a capital gains tax strategy to sell an asset and avoid the punitive taxes capital gains tax that would hit them if they sold it all for a lump sum of cash.

Rent-to-own homeowners should consult with a lawyer and see any relevant laws regarding how monthly rent payments must be applied. Affordable housing laws in your city or state may dictate how this part of the rent-to-own home agreement needs to be structured.

How to Find Rent-to-Own Homes

If you’re the potential seller looking for a rent-to-own arrangement, your best bet is to drive around your neighborhood (or the community you want to live in) and look for those big, red FOR SALE BY OWNER signs.

Real estate agents will most likely decline to get involved in a rent-to-own arrangement because they only get paid commission when a home closes. That said, you can probably ignore for sale signs associated with a realtor or realty company. You could try to knock on the door and see if the seller would be open to a rent-to-own arrangement– but owners who list with real estate agents typically need to work within the traditional home buying/selling process for many reasons.

You can also look for rent-to-own arrangements on online marketplaces like Craigslist. Keep in mind that even though a seller is not a bank, they can still run a credit check on you (with your approval) as part of the process. You will also still want to get a building inspector to look at the property before moving forward.

Rent-to-Own Homes Can Be a Great Option for Buyers and Sellers

A rent-to-own arrangement is great for buyers and sellers alike. It’s especially attractive to those who want to complete a real estate transaction without third-party interference (like a bank and/or a real estate agent).

Rent-to-own home buyers can avoid the need to secure a mortgage by paying the seller directly. It is especially helpful if the buyer cannot secure traditional home lending due to current debt or a low credit score.

Since the mortgage approval process can take weeks to months, rent-to-own home agreements can speed up the sale of a home. It can also offer the owner some unique rental property tax deductions since they will now be renting their property instead of selling it and paying capital gains taxes.

If you’re a real estate investor interested in selling a home with a rent-to-own agreement, consider scheduling a consult with one of our real estate asset protection experts. Our professionals are ready to create a rent-to-own home strategy that fits your unique real estate investment goals.

Kelly Madden

Kelly Madden

Kelly is a 14-year Air Force spouse, real estate agent, real estate investor, and virtual assistant. After starting out as an intern with ADPI in 2019 and later acting as ADPI’s blog coordinator in Jan 2020, Kelly is thrilled and honored to take on the role of ADPI’s new Community Manager as of November 2020. She looks forward to building our community and supporting our members throughout their real estate investing journey.
Kelly Madden

Kelly Madden

Kelly is a 14-year Air Force spouse, real estate agent, real estate investor, and virtual assistant. After starting out as an intern with ADPI in 2019 and later acting as ADPI’s blog coordinator in Jan 2020, Kelly is thrilled and honored to take on the role of ADPI’s new Community Manager as of November 2020. She looks forward to building our community and supporting our members throughout their real estate investing journey.
Share the love
Share on facebook
Facebook
Share on twitter
Twitter
Share on linkedin
LinkedIn
Share on pinterest
Pinterest
Share on facebook
Share on twitter
Share on linkedin
Share on pinterest

Receive Pro Tips & Insider Knowledge On How To Successfully Build Your Real Estate Empire

Team-photo-sidebar

Our team strives to educate, mentor and empower active duty service members, veterans, spouses and military families to reach financial freedom through creating passive income through real estate investing. Our goal is for Active Duty Passive Income (ADPI) members to own as much of America as possible.