Your risks when purchasing a home or condo
with “Rent-to-Own” real estate deal
“Rent-to-Own” or “Lease with an Option to Buy” seems like an attractive way to purchase a home in Long Beach or other locales in Southern California, especially if a renter does not have enough down payment money. But buyer be careful. These real estate deals are definitely not as simple as they may sound. And they may have some definite risks for you.
First, a definition: a lease-option can be defined as an owner’s offer to lease his/her property to a renter/prospective buyer while giving the renter/prospective buyer an option to purchase the home at a specific date in the future. The eventual purchase price is written into the Lease-Option agreement. (“Rent-to-Own” is simply a different way to express the Lease Option method of home purchase. They are the same thing.)
Typically, the renter/prospective buyer is required to make a substantial, non-refundable deposit on the property at the time the Lease-Option agreement is signed. For example, an owner may ask for $10,000 for the option and set a date of one year for the renter/prospective buyer to complete the purchase. During that one year period the renter/prospective buyer will have to make monthly rental payments.
Why the large deposit? The owners wants to be certain the renter/prospective buyer is serious. And the owner wants some financial protection during that period.
What risks and features you should look out for
Now this is where things become more complicated and risky–especially in today’s real estate market. Here is why:
1. The most disastrous thing that can happen is that the owner stops making mortgage payments during that year period and the house goes into foreclosure. Meanwhile, if the owner fails to tell the prospective buyer, the prospective buyer may be out of luck. By law, the one-time owner no longer owns the foreclosed property–a bank or loan company does–and that one-time owner can no longer legally sell the home to the prospective buyer/renter.
2. In a better scenario–with no foreclosure–if the renter/prospective buyer goes ahead with the purchase, the deposit may or may not be applied to the purchase of the home. And all or part of the rental payments may or may not be applied to the purchase. These items should be specified in writing in the original Lease-Option agreement.
3. At the end of the option time period, the comps or appraisals showing the value of the house may end up being lower–instead of higher–than the price specified in the Lease-Option agreement. The purchase price may have to be renegotiated although the seller or the buyer may resist this and the deal could fall apart.
4. If the renter/prospective buyer decides not to take the option of buying the house at this point, the renter/prospective buyer will probably lose the deposit entirely. The renter will probably also have to move out of the home.
5. At the end of the option time period, keep in mind that banks may have changed their requirements for mortgage loans. They may require 20% to 40% down payment and a very, very high credit score. Or the U.S. economy may have tanked. Or the renter/buyer may be facing personal financial issues. Or–and this is the most common result–the renter/buyer changes his/her mind and opts out of the deal.
6. Be sure to have professional advice if you decide to enter into a Lease-Option or “rent-to-own” deal. Have a real estate attorney or reliable experienced real estate broker advise you and demand an explanation every single clause in the agreement–before you sign it.
7. And remember–everything in real estate is negotiable!
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