When you don't have a down payment
Buying a Lease/Option Home
by Gary Foreman
Renting to Own
How to Decide between Renting or Buying a House
Should You Buy In a Neighborhood With a Homeowner's Association?
We would like to buy a house but don't have a down payment saved up. Friends say that there's something called a "lease option" that's like "renting to own" household furnishings. Is that really possible? How do they work? How do you set a price? Would we need a lawyer?
You've asked some very good questions. Yes, renting or leasing with an option to buy is a common transaction. But, it is more complicated than a lease or a standard home purchase agreement. So you'll have more things to consider than if you were either renting or purchasing.
Basically, you're renting the house just like any other rental. But, as part of the contract, you have the option to buy it during the rental period.
The purchase price of the home is negotiated up front and stated in the lease agreement. Look at the property as if you were buying it outright. That means you should get a qualified inspection and appraisal before you sign a lease. Bargain just as hard as you would if you were buying the home outright.
Don't assume that you can lease/purchase without a down payment. Some contracts, including homes that are seller financed, do require a down payment when the purchase option is exercised. And, like in other home mortgages, the amount of the down payment is negotiated between the lender and the buyer.
Expect to pay more each month than if you were simply renting. Typically part of your monthly payment will either contribute to the down payment or be the price you pay to have an option on the property.
If you are making a monthly down payment, write two checks, making one for the rent and the other for the down payment. You want to have a paper trail that demonstrates how much you've contributed towards the down payment. The bank will want to know.
Plan on keeping detailed records of every financial transaction. In addition to your rent and down payment checks, keep track of any other household expense that you have. Until you apply for the mortgage, you don't know what information the loan officer will want.
Your question presumes that the seller will carry the mortgage. That's not always true, and finding a mortgage on a lease/purchase can be tricky.
If the seller isn't going to finance, you'll need to do some research on mortgages before you sign the agreement. Make sure that you're reasonably sure to qualify for a mortgage when the time comes to complete the purchase.
Calculator: How Much House Can I Afford?
You'll want an experienced real estate attorney to draw up or review the contract. Tell them what you want to accomplish and let them choose the right documents. There are a number of different ways to legally set up a lease with option to buy. The documents you choose may have tax consequences and/or have an effect on your ability to get the mortgage you want. This is no place for do-it-yourself legal work!
Make sure that your attorney talks you through the various outcomes. Know what will happen if you decide to buy the home or what the effects will be of not renewing your lease. Also, make sure to discuss what happens if you need to break the lease.
Be prepared for the housing market to go down. Since 2008, we're all painfully aware that housing prices can go down, too. You could find that your option price is more than the house is worth in a few years.
Consider, too, that you might not be ready to own a home. It's natural to not want to wait while you save a down payment, but there's a reason that lenders want a down payment. The time you take to save it could be well spent if you use it to strengthen your finances and improve your credit score.
Your friends may be right. A lease/option could be a good way for you to get your dream home without a down payment, but it does have drawbacks that you need to consider before you make any commitment.
Reviewed August 2017
Gary Foreman is a former financial planner and purchasing manager who founded The Dollar Stretcher.com website and newsletters in 1996. He's the author of How to Conquer Debt No Matter How Much You Have and he's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money, Credit.com and CreditCards.com. Gary shares his philosophy of money here. Gary is available for audio, video or print interviews. For more info see his media page.
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