You want to purchase a home in the Charlotte area, but past credit issues have prevented you from getting a loan. You evaluate your options and think a lease purchase program makes sense, but does it really?
A lease purchase program, also called a rent to own or lease to own program is an option some people consider in an attempt to make the dream of home ownership a reality. The premise of a lease purchase program is that you can rent a home, earn monthly credits while doing so and eventually, after one or two years, qualify to finance the purchase of that home and use the rent credits earned towards your down payment. This type of program usually involves an option fee, payable upfront (you pay for the right to buy the house at a predetermined point in time). This non-refundable fee is usually between two to three times the monthly rent. For example, you might elect to do a lease purchase program on a home for $1,000 per month with $2,000 down and $150 monthly rent credits. During the lease period, you will have to repair your credit so you can qualify for a loan when your lease expires. The rent credits are a nice way to save money on a monthly basis since those credits will be used towards your future down payment. Unfortunately, that’s really the only benefit of a lease purchase program. You would be better serve to keep renting for now or rent a home during the time you repair your credit. Here is why:
Higher monthly rent
Even though you will earn monthly rent credits with a lease purchase program, what you end up paying per month will be higher than what you would normally expect to pay to rent a similar home. For example, if you are doing a lease purchase on a home with $1,000 monthly payments and $150 monthly rent credits, you are basically over paying $150 per month to live in that house. When the option period (the lease) expires, if you are unable to secure financing to purchase that home, or decide for any reason that you don’t want to buy that home, you will lose all those rent credits.
The option fee is not a deposit. It’s a fee and it is non-refundable. That means that if you cannot secure financing or change your mind about buying the house you are leasing to own, you will forfeit that money. Since the option fee can be as high as three times the monthly rent, it adds up.
Qualifying for a loan
A lease purchase program usually lasts one to two years. After that, you need to pre-qualify for a loan in order to finance the purchase of the property. Lending guidelines always change and may not be the same at the end of your lease. And if you can’t qualify to own, you will lose your option fee and your rent credits and be back to square one.
An attorney needs to review the lease purchase agreement
Lease purchase programs are complicated. The terms in a lease purchase program vary. Terms, final purchase price and amount of rent credits to be received need to be spelled out. For this reason, you should have an attorney review the terms of the lease purchase contract and attorneys cost money.
Limited home choices
Only a few companies and homeowners offer lease purchase programs. That means the selection of homes available for this program is limited and most likely, you will be settling for a home instead of choosing a home you really like. There are thousands of homes for sale in the Charlotte area and only a few dozens rent to own homes. Buying a home is the largest investment most of us make in a lifetime. You don’t want to settle for a house just because your credit is not where it needs to be today.
Future home values
Home values are cyclical, though in normal times, you would expect homes values to increase slowly over time. What would happen if the home you are leasing to own depreciates in value overtime because of foreclosures in the neighborhood or an unforeseen economic down turn? The purchase price you agreed to on your lease to purchase contract might be more than what the house is worth when you are ready to buy it. A lender will not loan you more than what a home is worth and consequently, you might have to put a larger down payment or walk away from the home altogether, hence losing your option fee and rent credits. There is simply no guarantee that the appraised value of a home today will be more than its appraised value when your lease ends.
Interest rates play a major factor in how much you can afford to borrow. The lower the rate, the more you can borrow for the purchase of a home. The reverse is true. As of the time this post was written, interest rates are at record lows, but they will eventually go up and that could cause a problem with a lease purchase program. To determine how much you qualify for, a lender will look at your debt to income ratio and come up with a number. Basically, you front end ratio should not be more that 28% (which means that your monthly mortgage payment should not exceed 28% of your gross monthly income) and your back end ratio should not exceed 36% (which means that your monthly mortgage payment and other monthly payments on revolving debt should not exceed 36% of your gross monthly income). A mortgage payment is made up of repayment for the principal amount of the loan, the interest, property tax and insurance. If rates go up too much and you are already close to your maximum debt to income ratio when starting your lease to purchase program, you might not be able to move forward with a purchase when the option period ends, hence risking to lose your option fee and rent credits.
We point out this issue, because we have heard it from people who have lost their option money and rent credits because the homeowner did not pay the mortgage. This is one of those situations which is more common than you would expect and could end costing you a house, as well as your option fee and rent credits.
If though you are doing a lease purchase, it still is not your house until you buy it (or finance it). If you decide to make improvements to the property and can’t or decide not to move forward with a purchase at the end of the lease period, you will have to pay for the cost of removing the improvements and if the owner accepts, leave them with the property, therefore improving the property to the benefit of the homeowner for free.
In our opinion, a lease purchase program benefits sellers who are having a hard time selling their homes, not home buyers. It is much more advisable to hire the services of a credit repair company, talk to a lender or contact us to find out what your options are about repairing your credit before signing a lease to purchase contract.