Rent-to-own housing is tricky trend, experts say
Tenants looking for rent-to-own agreements are creating a growing trend in the rental market, but experts caution that such contracts contain pitfalls that can surprise both the landowner and renter.
“I’ve been at this 37 years and I have not seen many ever work,” said Hillsboro Mayor Delores Dalke, a longtime real estate broker.
A rent-to-own agreement, also called a lease option, involves someone renting a home and paying for the option to buy it at a later date. A portion of the rent counts toward a down payment, which appeals to those having difficulty saving enough money for a traditional down payment.
Although rent-to-own agreements vary in their terms, a renter chipping away at the principle with each payment is considered more invested in the property and more likely to make on-time payments.
Still, Dalke said, missed payments occur. Many rent-to-own agreements stipulate that a missed or late payment can void the agreement, meaning the renter forfeits whatever equity he has built up through previous on-time payments.
However, homeowners will often forgive a late payment or two in hopes the renter can re-establish on-time payments so that the sale of the property proceeds, Dalke said.
It does not always work out that way, Dalke added, and that is because at the end of a typical rent-to-own agreement a renter must obtain a mortgage from a traditional lender, which requires more money going toward the principle than the amount paid in excess of the normal rent on the property.
For example, say a renter pays $400 a month for a $50,000 home, which would also be a typical monthly mortgage payment on a similarly valued home. If the taxes and insurance on the home total $150 a month, then the lender would insist that the rent should have been $550 a month. In this scenario, the lender would determine that the renter has not actually accumulated any down payment.
“It happens all the time,” Dalke said. “Most people don’t know that.”
Lenders also balk at deals involving a renter who has missed rent payments, since that indicates difficulty making mortgage payments, Dalke said.
Dalke and Lori Heerey of Heerey Real Estate in Marion agreed that a homeowner without a mortgage has the ability to set whatever creative financing terms he likes and is a renter’s best bet to strike a deal.
Heerey works to broker land contracts, which are slightly different from rent-to-own agreements.
Land contracts typically involve a seller who owns his property outright. The seller acts as the bank and is “carrying the note” or “holding the paper,” as it is often called in the mortgage industry.
A typical land contract includes the tenant paying for the cost of insurance and taxes on the property, Heerey said.
“It just makes (renters) more connected to the house because they are more invested in it,” Heerey said.
The length of a typical land contract could be from two to 10 years, Heerey said.
Although the majority of the land contracts Heerey works on involve a seller who owns his property outright, some homeowners are still making mortgage payments. Those property owners must gain permission from their lender in order to enter into a land contract to sell their property.
But lenders often oppose land contracts if the house is supposed to be the owner’s primary residence. Renting out a home to a tenant makes the house a commercial investment subject to higher interest rates.
Both land contracts and rent-to-own agreements can establish escrow accounts for payments, and the recent popularity of both stem from a common economic reality for many renters.
“They don’t have money for a down payment and can’t get a traditional loan,” Heerey said.
Last modified March 4, 2015