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Home Buying The Pitfalls of “Rent to Own” and How to Protect Yourself as the Tenant-Buyer
The Pitfalls of “Rent to Own” and How to Protect Yourself as the Tenant-Buyer

realpropertycheck.com September 26, 2010

The Pitfalls of “Rent to Own” and How to Protect Yourself as the Tenant-Buyer

“Rent to Own” sounds like a dream come true to many aspiring homeowners. Given current credit conditions, such deals look very enticing.

Banks are no longer willing to discuss deals which might even remotely resemble some of the now-outlawed lending practices of the sub-prime bubble, and understandably so. But similar lending standards are now being applied outside of the financial system, away from established lending institutions, as evidenced by the many “Rent to Own” deals which are currently flooding places like Craigslist.

“Rent to Own” deals often attract buyers who cannot document two years’ employment history or put up meaningful assets as a security in order to obtain a conventional loan. Even though such buyers do have a sizable down payment and sufficient income to service the debt, they feel locked out of the credit markets. By entering into ready-to-sign agreements with investors, tenant-buyers often assume a far higher risk than they are aware of. They often pay outrageously high price for a promise they cannot really enforce.

Behind the Scenes of “Rent to Own”: The Real Deal

In a Rent-to-Own deal, the tenant-buyer puts down a sizable lump-sum, receives the keys to the property and takes over monthly payments from a distressed seller through the hands of an investor-middleman (who gets his or her own cut, month per month, but assumes no risk of their own).

The seller is often a distressed homeowner who got in well over their head at the peak of the housing bubble and wants to offload his monthly payments onto the shoulders of somebody else. Tenant-buyers tend to be aspiring homeowners who are fed up with rending but need time to rebuild their credit. To the buyer, the opportunity for collecting some “equity” in the process seems like a fair deal. But too often he or she is blithely unaware of the perils of a ready-to-sign Rent-to-Own-agreement which is structured without proper protections of the buyer’s interests in place.

A Rent-to-Own deal is most often structured as a lease option agreement. After a few years of timely payments, the buyer-tenant is promised an opportunity to close on the property for the amount of the remainder of the original mortgage, as it is being reduced over the lifetime of the lease. This should make it easier for the renter-buyer to obtain bank financing for the ever-dwindling remainder of the mortgage at some point in the future. That’s the general idea. But what if the seller pulls back? What if they are foreclosed upon? What if they file for bankruptcy? What if the middleman embezzles part of the funds? How do you go after them and will it be worth it?  On top of that, only a generally small fraction of the monthly payments is being applied towards the final purchase price and the premium over a lease can be steep. Should you wish to enter into a Rent-to-Own agreement, make sure you protect the downside and make sure the deal is worth it.

This is what can happen in a “Rent to Own” scenario gone bad and how you can protect your interests as the tenant-buyer:
Lease Option: How to Protect Your Interests in a Property

Filed Under: Buying, Homeowners' Club, Investing, Selling Tagged With: lease option, Rent to Own

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