Rent-to-own, lease-to-own, lease-purchase, lease-option: all these refer to an arrangement that allows you to live in a home prior to purchasing, and can provide a wonderful opportunity or a recipe for disaster. This guide will help you avoid some common mistakes and properly prepare for, find and eventually purchase your new home in a way that will be trouble free from start to finish.
1. Determine how much house you can afford and how much loan you will qualify for:
In addition to deciding how much of a monthly house payment you can afford- both before and after you purchase, you need to determine how much mortgage financing you will likely qualify for when you’re ready to purchase your new home. Just because you can afford the monthly lease payments doesn’t mean you’ll be able to afford the monthly mortgage payments or even qualify for a sufficient mortgage to purchase.
The best person to help you with this is an experienced mortgage broker or loan officer. This is not something you should do through an online service, but through a real mortgage professional in your area. The mortgage loan officer at your local bank may be able to help, but your best bet is an experienced mortgage broker.
2. Determine what you need to do to qualify for a mortgage and how long that will take:
Again, this is where your mortgage broker can help. Even if you’re not able to qualify for a mortgage now, he or she has the tools and experience to carefully review your credit/income/debt scenario and recommend the steps you will need to take to qualify. Once you have this information, it’s important to consider very carefully and conservatively how long it will take you to get this done and how long a lease-purchase term you will need.
If you’re looking for a home in the Raleigh NC Triangle area, our Mortgage Associate will be happy to assist you with steps 1 and 2, and throughout the entire process.
3. Determine how much initial down payment you can afford:
This is the amount paid toward the purchase when you sit down to sign the contract with the seller. Every seller has different requirements and formulas for determining how much of an initial down payment they require, but this amount plays an important role for both the landlord/seller and tenant/buyer:
For the landlord/seller, the down payment provides assurance that you are serious about purchasing the property and have a good running start toward the total amount you will need (closing costs, lender required down payment) when the time comes to purchase. And if for some reason you fail to purchase, this deposit is the only consolation the seller has for taking the property off the market for an extended period of time and having to start all over to find another buyer.
For you, the tenant/buyer, the larger your initial down payment, the less money you will need to bring to the closing table when you’re ready to buy. For instance, if the total amount you will need at closing is $10,000, a $2,000 initial down payment would make everybody nervous about whether or not you’re serious and can save the additional $8,000 needed to purchase.
4. Shopping for a home!
Having consulted with your loan officer, you now know how much home you can afford, how much time you need before you will be ready to purchase, and can start looking for a home that meets these and your other requirements.
We hope you will bookmark this site and check back from time to time to see if we have a home that might be a good fit for you, but if not, the best places to look online are sites like craigslist, hotpads, oodle, backpage, zillow, trulia, etc.
Tip: Don’t limit your search to ads that specifically offer a rent-to-own or lease-purchase. Look at any homes for sale, especially those that appear to be vacant. Those sellers may be making payments on two houses and might welcome a lease-purchase buyer who’s monthly payment will cover their mortgage payment!
Tip: Avoid homes with monthly rental payments significantly higher than what your mortgage payment will be after you purchase, unless a generous credit toward the purchase is included. We keep the monthly payments on our homes right in line with what your mortgage payment will be, unless the buyer needs down payment assistance, in which case we sometimes raise the monthly payment, with the additional amount credited to the purchase.
5. Contacting prospective sellers:
When contacting prospective sellers, provide them with a reasonable amount of information about your situation. Explain that you are working with a mortgage loan officer and have done your homework to formulate a solid plan that will enable you to eventually purchase. It’s perfectly reasonable that most lease-purchase sellers will want to do some pre-screening, even before showing you the home. After all, why waste your time and theirs if you don’t meet their basic requirements.
Likewise, be sure you get all your questions about the home and the lease-purchase terms answered before heading out to view a property. Have a checklist ready when you talk to the seller for all the basic information.
6. Before applying, be sure the price is right:
So you’ve found the home of your dreams- congratulations! But don’t go charging ahead to fill out an application unless you are satisfied with the price and terms.
The purchase price should be no higher than what the home will appraise for right now. You can check recent comparable sales at sites like Zillow, but take their “Zestimate” with a grain of salt- it can be hit or miss. Pay more attention to recent sales (within 6 months) of similar homes in the same neighborhood or very nearby. If the price of the home seems too high, ask the seller how they arrived at that price. If you’re not satisfied with their explanation, you should probably pass on this one.
Tip: Even if the home appears to be priced appropriately, ask the seller if they will agree to a reduced price and/or pay some of your closing costs if you are able to purchase sooner, such as within the first few months.
7. Applying for a lease/purchase:
Most sellers will require a written application form to determine if you meet their requirements, specifically, that you have sufficient income, good rental history, and a credit scenario that can be improved sufficiently within the lease term to allow you to qualify for a mortgage. Invite the seller to contact your mortgage broker or loan officer for details of your plan.
8. Before signing contracts:
If your application has been approved, you will no doubt be eager to seal the deal and get the keys to your new home, but slow down! At this point you need some important additional information:
Ask the seller to provide you with copies of the most recent statements for all mortgages and liens on the property.
If the seller owes more on those mortgages and liens than your purchase price, you will need to say “thanks- but no thanks” and abort, because this means that when the time comes for you to purchase the home, the seller will have to bring cash to the closing to make up the difference, and there is no way to guarantee that they can or will do this. The only solution would be for the seller to pay down those liens before you enter into an agreement.
If one of the liens is a HELOC (home equity line of credit) treat the entire available credit line as a lien. For instance, if there is a $50,000 HELOC, even if that account only has a $10,000 balance it is still a $50,000 lien, because the seller can write a check at any time for up to the maximum available credit line of $50,000.
This information will also allow you to determine if all mortgages and liens on the property are current.
Some sellers may initially be surprised by this request, and may even say “it’s none of your business”, but any seller who balks at providing this information, after you’ve explained your reason for requesting it, is not someone you want to do business with.
If you want to be super careful about discovering any problematic liens on the property, you can have an attorney perform a title search.
9. Before signing, review contracts carefully:
Review any contracts very carefully before signing to be sure that they contain all the terms and provisions promised by the seller. In addition to all the usual provisions contained in a lease or rental agreement, a lease-purchase agreement should contain most of the provisions and protections for buyer and seller found in a standard purchase agreement.
Seller Mortgages and Liens: In addition to the obligation of the seller to keep all mortgages and liens current prior to closing, there should also be some arrangement for you to periodically verify this throughout the term. Failure of the seller to keep all liens current should allow you to cancel the agreement and receive a refund of any deposits.
Price Protection: Be sure that your contract protects you in the event that the property does not appraise for the purchase price when you’re ready to buy. Market conditions can change during your lease-purchase term, and you should never have to pay more than the appraised value, even if that is less than your contract price.
Inspection: If you’re planning on having a professional home inspection, there should be provisions in the agreement for this and it should be performed and any repair issues resolved before you move in. If you move in first, and discover major items the seller is unwilling to repair, this could cause a serious train wreck!
The above suggestions should not be considered as legal advice. We are not attorneys. If you are uncertain if the agreement provides adequate protection, or contains provisions you don’t understand, review it with an experienced real estate attorney before signing.
10. Move in and move forward to success:
OK, so you’ve done your homework and moved into your dream home. Congratulations- but you aren’t done yet. Your new home is yours to buy or to lose, depending on what you do from this point forward. Here’s what you need to do to succeed:
- Have a plan and stick to it. If you’re working on improving your credit, your mortgage loan officer is your best friend. Do everything he or she recommends- not later, but now. Do not make any financial decisions or major credit purchases without his or her blessing.
- Have a budget and stick to it. If you’re saving additional down payment or paying down debt, have a schedule for this that is non-negotiable. Just do it. You may have a 12 month lease-purchase term and think you’ve got plenty of time. Think again! 12 months can go by in a heartbeat, if you don’t have a plan and stick to it.
- Be a good tenant/buyer: Make all your payments on time and honor all your obligations under your agreement.
In 14 years of selling homes through lease-purchases, I have never seen a tenant/buyer fail who has followed this advice. In fact, if you follow these simple, common sense suggestions, your lease-purchase experience is almost certain to be smooth and satisfying, resulting in the successful purchase of your new home.