You’re about to learn why this could be one of the worst mistakes a buyer could possibly make.
Are there any positives? Sure there are, and we’ll discuss those as well.
First off, every person’s situation is different. In some rare cases, this may be your best option, but typically, this kind of arrangement is extremely disadvantageous to the buyer.
The best way to explain this concept is with a specific example:
- Lets assume that for whatever reason you are either unable or uninterested in purchasing a home through a more conventional way.
- Lets also assume that you found a home you really liked and have agreed on a purchase price of $500,000 for this home.
- Finally, lets assume that the market rent for this home should be about $2,200 per month.
“Luckily” for you, you’ve found a seller that is willing to give you a Lease Option, which is another word for rent-to-own. The reason it’s called a lease option is that after a pre-determined period of time leasing the home (typically about 3 years), you will have the option to buy it for an agreed-upon price.
The first step is negotiating your contract with the seller. All sellers want a lump sum upfront (typically around 5%), and after a little negotiation, this is exactly where you end up: 5% or $25,000. This money is paid to the seller up front, but will be applied towards your down payment once you decided to buy.
Next you negotiate rent. All sellers expect above market rent, but this one tells you that anything over market rates will be applied towards your down payment. You negotiate a rent of $2,500 (fairly typical). Which means that $30o/month *12 months * 3 years = $10,800 that you are “over-paying”, will be applied towards your home purchase.
Lastly, is an unexpected issue of repairs and maintenance. Since you are not only the tenant but the future owner of the home, it is most common that you will be the one responsible for the cost of repairs and maintenance. There is no pre-defined number here, but lets just say conservatively an estimated $3,000 over three years.
At this point… this isn’t such a bad deal or too unexpected? Right??
Well yea, if you end up buying the home, it’s not such a bad deal.
But what happens if you don’t buy the home?? – If you don’t buy the home, you will lose almost $40,000 over three years.
Now I know what you’re thinking, “Why wouldn’t I buy the home?” – Great Question – I’ll split up the answer into two sections:
- You changed your mind.
- It’s just not as big as you thought
- You can’t stand the neighbors
- The home makes weird noises or has ghosts … or any number of reasons where you just changed your mind.
- Home prices in the area are starting to decline and you realize that this is not the time to be a home-owner.
- After conducting inspections that you didn’t previously do, you discover issues that you weren’t aware of before… such as cracks in the foundation or other “big deal” items.
- Job Loss
- Death in Family
- Addition to the family
- Relocation (work or otherwise)
- You try to buy the home but your financing falls through: (Is that really likely? – YES! It’s VERY likely– Who knows what’ll happen in 3 years!
- Interest rates might be higher than they were 3 years ago and you can’t afford the monthly payments
- Your family income or expenses changed and you’re no longer qualified for the same rate/loan
- The home has lost value and only appraises for $450,000 so you would have to pay the difference.
- Any number of other changes that could effect the lending climate and make you unable to qualify for a loan.
The point I’m trying to make is that even if you don’t consciously change your mind, there is a very high risk of “something” coming up and making you unable to purchase in the time-frame of the option.
What if your roof leaks, and there is just no fixing it – it has to be replaced and there’s an unexpected cost of $10,000+
And what happens if 2 months later (around year 2) you lose your job and can’t make the rent payment?? … The agreement is cancelled and your money is gone.
Lastly, what if you do everything right, but the seller has financial problems and stops making loan payments. The home will be foreclosed on, your contract will be terminated, and you will once more lose your entire investment.
So all of the risk is on you as a buyer, while all of the rewards go to the seller.
In my opinion, the far better option is to rent for 2-3 more years, improve your credit, save extra money and then buy a home the regular way without any of the risk.
I did mention that there are positives … but the fact is, I can only think of one positive:
- If real estate prices in your area are increasing rapidly, like perhaps in 2005-2007, then this is a good opportunity to lock in a home price before it gets out of your reach. That same $500K house today might be worth $700K in 3 years. – This of course should not be an issue in today’s market.
If you’re still thinking about pursuing this option, please send me an email because I would be very interested in hearing your logic.
Or if you’d like, I can recommend a fantastic mortgage expert who can guide you from which-ever financial point you’re at now, to where you need to be to become pre-approved for a loan. That way, 2-3 years from now you will be buying a home without any of the risks above.
And, as always, if you have any questions, I’d be happy to discuss this topic, or help you analyze your particular situation. CONTACT US today for a free consultation!