June 2019

You want to buy a home, but you really, truly don’t have the money. Can you get started anyway with a rent to own agreement? Let’s answer this question: “how does rent to own work?”

Most prospective homebuyers want traditional mortgage financing. They want to be able to go to a bank, get a low interest rate, be offered reasonable closing costs, and they want to maximize their home-buying power. The problem is that with a poor credit score that can be due to any number of factors, traditional financing just may not be available for all home buyers.

But really, how does rent to own work?

Well, while renting a home may be attractive to some because of the low maintenance costs and the ability to move without the problems of listing and selling a property, many feel that money spent toward rent is totally wasted since in effect, the tenant is paying the landlord’s mortgage.

There is, however, a method that allows a tenant to get future equity in return for their monthly rent payments, and that is called rent to own. So, now you’re asking, how does rent to own work?

How Does Rent to Own Work

Investopedia explains rent to own in a simple and understandable manner:

• A rent-to-own agreement is a deal in which you commit to renting a property for a specific period of time, with the option of buying it before the lease runs out.
• Rent-to-own agreements include a standard lease agreement and also an option to buy the property at a later time.
• Understand that lease-option contracts give you the right to buy the home when the lease expires, while lease-purchase contracts require you to buy it.
• You pay rent throughout the lease, and in some cases, a percentage of the payment is applied to the purchase price.
•  With some rent-to-own contracts, you may have to maintain the property and pay for repairs. 

Executory Contract

Rent to own deals are usually designated by law as executory contracts. legaldictionary.net gives us a nice definition here:

An executory contract is a contract made by two parties in which the terms are set to be fulfilled at a later date. The contract stipulates that both sides still have duties to perform before it becomes fully executed.”

Each state has specific rules and guidelines regarding executory contracts and rent to own would fall under that umbrella. And while rent to own has been in existence for many years, because of landlord abuses, some state courts—like these in Texas, for example—have been more tenant-friendly than landlord-friendly when rent to own disputes arise. 

Minnesota Statutes sections 325F.84, et. seq. require that:

The lessor is regularly engaged in the rental-purchase business;

The agreement is for an initial period of four months or less, whether or not there is any obligation beyond the initial period, that is automatically renewable with each payment and that permits the lessee to become the owner of the property;

The lessee is a person other than an organization; and

The lessee takes under the rental-purchase agreement primarily for a personal, family, or household purpose.

How It Works — Exactly

Rent to own can appear in different forms, but many times the landlord will offer to take a portion of the month’s rental price and apply that to either a down-payment for the house, or to the full purchase price. This purchase price must be agreed upon in advance, and the tenant must agree to purchase the home at that price.

For example, if the tenant has agreed to pay $200,000 for a home, and in the meantime rents the home for $1500 per month, the landlord may offer a rent to own deal where $500 of the monthly payment is credited to either a down-payment—in the case of seller financing—or to the purchase price.

If the tenant lives in the home and makes all of their payments for 10 years, this would equal $60,000, and if the term had been set at 10 years, the landlord would be obligated to sell the property to the tenant for $140,000.

The tenant must carefully think about contract terms and consequences because if they are unable to get conventional financing for the home after the 10-year period, there needs to be an agreement for resolution of this problem. Either the landlord would have to offer seller financing, or maybe even refund the tenant’s $40,000. It must be emphasized that individual rent to own contracts can differ greatly, so tenants are advised to get quality legal representation.

Abuses

Some rent to own contracts are written to favor the landlord, and, in the past, predatory landlords would offer a rent to own deal to a tenant knowing full well that the tenant would not be able to afford the monthly payment. If a tenant missed a payment, the landlord could void the rent to own contract and evict the tenant. This way, the tenant would lose all of their investment, and the landlord would be free to perpetrate this abuse again and again. This is one reason that Texas views rent to own executory contracts with a very wary eye. All in all, if you’re a Minnesota renter living in something like a one-bedroom apartment, be sure you know all of the potential rent to own issues that could arise.

Other Issues

Other issues to consider are:

• Who pays the property taxes?
• Who is responsible for maintenance?
• Who replaces broken appliances and/or major systems?

All of these potential problems need to be spelled out carefully in the rent to own contract. We strongly suggest that prospective rent to own tenants and landlords do not download generic executory online contracts and then attempt to tailor them to a particular situation because this action can be the proverbial recipe for disaster.

Rent to Own Alternatives

Rent to own can be a decent method to at least get some monetary credit for monthly rent payments, and it can be successful if both the tenant and landlord are forthright and have the same goal of enabling the tenant to own the property one day.

We do suggest that anyone that has been denied traditional mortgage financing consider MN contract for deed financing. Contract for deed is also non-traditional home financing, but it is also a great alternative to just renting.

So, you are planning to list your property on the market, and you want to get as much return on investment as possible, but you don’t know how to go about it.

The secret lies in the type of renovations you do in the house. Note however that some renovations may make the house look fancy, but they do not, in any way, increase its property value. For instance, a backyard pool in an area that is generally cold will do very little to persuade a potential buyer to purchase the property. You should therefore, focus on upgrading areas that are likely to capture a buyer’s attention like the kitchen, bar and bathroom. This will save you both money and time to capitalizing on a booming market. So, how do you increase your property value in a year

Remodeling the kitchen

According to Michael Deane, editor of Qeedle, a small business magazine, “the kitchen is the heart of the home and is the place the buyer is likely to pay attention to the most. To remodel the kitchen, start with painting its walls.”

This may seem straightforward, but do not underestimate the power of the paint. A good paint job can convert an old kitchen to a brand new one, while a poor job can do the opposite. Also, you need to replace old appliances with new ones or even add more, if your kitchen has a shortage of appliances. Go for stainless steel appliances as they are more durable and have a stylish and alluring look that can blend in with any decor. You can also replace worn out cabinets and countertops, replace old flooring with more modern options like tiles and vinyl and even include a backsplash in the new design.

For safety purposes, care to install a fire duct or a range hood. A fire duct removes smokes and nasty odors from the kitchen and also reduces fire risks by expelling grease vapor from the kitchen. Grease buildup in the kitchen may act as a fuel source for the fire. Lighting is also equally important. You can get rid of too much overhead lighting in favor of wall mounted light sources to give the kitchen a tranquil feeling. There are also many kitchen layouts you can choose from depending on the size and shape of your kitchen. However, an island layout is the most popular and you can take advantage of it, if it is not already in place.

Remodeling the bathroom

In all areas of the house, the kitchen and the bathroom have the highest traffic. However, the bathroom takes the most beating and is the area that is most likely to gross out the buyer, if it is not renovated well. Luckily, the bathroom does not require as much work as the kitchen. The first step is to replace those rundown faucets and clogged shower-heads with new sleek ones. You can install under-mount sinks, instead of drop-in sinks or even include marble or granite for countertops to make it more interesting and modern.

The bath area is where the action takes place. Therefore, you need to make it as special as possible. A good way to start is to install a shower with body sprays or even surround the bath area with beautiful tiles or decorative stones. As for the floor, you can revive it with new grout to cover up dirt and grime that could have accumulated over the years. You may even surprise the buyer with heated floors – trust us, it will blow their mind. Nothing attracts buyers to a house like heated flooring. Also, replace overhead lighting with wall lighting, as it adds warmth and serenity to the bathroom. You should also replace worn out curtains and rugs and ensure the bathroom is spotlessly clean.

Ensure there is curb appeal

Keep in mind that first impressions last. In this case, your curb will give out the first impression of your house. Give the buyer a reason to go into the house by making the front your home look attractive. If it has a curvy walkway, you can make it more alluring by accentuating it with colorful flowers, nicely mown lawn, beautiful grass and even light lanterns. You can also install a new mailbox, shutters, and a deck or even build a new driveway. Also, make sure to plant native trees both at the front and the back, as trees have been found to increase property value considerably.

Install security fixtures

In the US, a house is broken into every 15 seconds. As a result, security is the number one consideration for buyers when looking for a house. You need to proof your house against unlawful entry by installing a security alarm system that goes off when there is a breach. Also, include external lighting and install sturdy wooden doors and window locks. Aside from unlawful entry, you can also disaster-proof your house from fire hazards by installing a fire alarm system and a fire duct. As mentioned earlier, a fire duct system can help reduce fire hazards and keep the house free from nasty odors and smoke. Check out our article on ways of disaster-proofing your house.

Renovating your house is the only way of increasing its value. We would like to caution however not to go overboard with the renovation, as this will likely increase the value of the house beyond what the buyers are willing to pay. For instance, adding luxury fittings and custom features may not work in a middle-class neighborhood, as the house will be beyond their pay grade. Therefore, you should consider the immediate surroundings when doing the renovations. If your property is old (built before the ‘70s), then it probably has an outdated plumbing system, lead paint and asbestos fittings. Ensure the plumbing system is updated and the lead paint and asbestos fittings are completely removed from the house, as required by law. You can check out our tips on how to upgrade an old home here to increase its market value.

You’ve saved some down payment dollars, you’ve checked your credit and made sure that there are no inaccuracies on your credit report, and you really want to take the next and become a homeowner. You’ve searched endlessly about how to afford a house.

Your question now is, “How do I figure out the price range of houses I should be considering? What can I really, truly afford?”

The answer is logical and can easily be calculated.

Debt to Income Ratio – What Does It Mean?

Lenders need to know that you will be able to make your housing payment. Since your mortgage will be the most important payment you make, you might think that it is out of the question to even consider being late or missing a payment, but because foreclosure takes some time, more homeowners than you think will stop making their housing payments when they get into trouble.

In fact, during the financial meltdown that occurred beginning in 2008, lenders were surprised at the number of what they thought were quality mortgagees that suddenly just stopped making their payments.

Lenders have historically used the debt to income ratio to qualify applicants, but since 2008, this number has become more formal, and conventional lenders have less leeway than they might have had before that time.

Depending upon the loan program and lender you choose, your debt to income ratio will need to be no more than 36 to 43 percent of your income.

Therefore, if you make $10,000 per month, you mortgage payment including taxes and insurance should not be more than $3600 to $4300. Before the financial crisis, some sub-prime lenders ignored the debt-to-income ratio altogether, would accept ratios higher than 50 percent, would ignore some debt sources like student loans, or would take the word of an applicant regarding their total income without proof.

All of these things led to disaster.

How to Afford a House with Down Payment Assistance

Your down payment reduces your monthly payment because your mortgage loan will be less, so first accumulate all of the down payment dollars that you can, if you’re wondering about how to afford a house. Some states offer down payment help, and many lenders will allow you to receive a gift for part or all of your down payment. If you are buying a $200,000 home, and you have a $20,000 down payment, you know that the mortgage loan you are looking for will be $180,000.

Mortgage Calculator

Next, use a mortgage calculator to see what your monthly payment would be. The good calculators will allow you to add monthly property tax and insurance payments to this total. Let’s look at a $180,000 30-year mortgage. We’ll use five percent as the rate and the principal and interest you would owe monthly would be approximately $966.00. Add a $150 property insurance premium and $250 per month for property taxes and your payment would be $1366.00 per month.

Please note that property tax rates and insurance costs vary widely, and these figures are for example only. If we multiply $1366 by three that would give us the amount of income you would need to support a comfortable debt-to income ratio of 33 percent, and that amount would be $4098.

Sources tell us that lenders usually look at gross income, so to afford your $200,000 home after you have made a $20,000 down payment you would need a monthly income of a $4098 or close to $50,000 per year.

What About Differences?

Higher interest rates will off course cut your home buying power. Mortgage principal and interest for a $180,000 loan at five percent jumps $230 per month at seven percent but would drop $210 at three percent, so be aware of interest rate changes.

Closing Costs, Too?

One thing to watch out for is closing costs that can equal four or more percent of your total loan. Therefore, if your loan amount is $180,000, your closing costs could be $7200 or more, and you need to include these in your home purchasing budget. Your Realtor can help you try to get the seller to cover some of these costs, however.

How to Afford a House with Pre-Approval

While the process of figuring out exactly how much home you can afford may look like a lot of work, if you go to a bank or lending institution and ask to get pre-approved for a mortgage, they will do that work for you. The pre-approval process requires verification of your income and debts, but this will have to be done anyway sometime during the mortgage loan process. A lender will know exactly what to ask you for, and after they have received your information, the lender can advise you of the mortgage amount you are pre-qualified for. Also, when you are in receipt of a pre-qualification letter, you will be better presented to sellers as a serious buyer.

Types of Loans

Remember to consider the various mortgage types available. 15-year loan terms mean that if you make all of your payments in 15 years you will pay off your mortgage in half the time it would take you to retire a 30-year loan. The monthly payments will be higher, but the savings over the loan term with a 15-year v. a 30-year loan can be staggering.

Alternatives

Remember, while conventional financing is preferable, there are circumstances where it just may not work for you. If you have recently declared bankruptcy, had a foreclosure, are behind on credit card bills or student loans, your ability to obtain a convention mortgage loan may be hindered.

If that’s the case, be sure to check out programs like contract for deed as these home buying options can definitely be a great alternative to conventional mortgage financing.