There are several ways to purchase a house. Most people are somewhat familiar with traditional financing. You apply for a mortgage, are pre-qualified, then pre-approved, find a home and submit a purchase offer. After your offer is accepted, you go through the inspection and appraisal process and finally close on the property. But, in some instances, even buyers who are pre-approved for mortgages are denied financing. While this is certainly a setback, there are other options — land contracts and lease-to-own.
About Land Contracts or Contract for Deed
You might have heard these terms before; or, these are completely new to you. Whatever the case, there’s usually confusion about the differences and which is more advantageous. The two are quite similar but one is more preferable. In a land contract, also known as a contract for deed, you rent or lease. Each month, the payment is considered an installment, which means the seller is financing the purchase.
“Lease-to-own contracts (LTOs) and land contracts (LCs) are different legal ways to accomplish the same objective: transferring occupancy of a property from an existing owner who no longer wishes to occupy it to someone else who does want to occupy it, but who cannot afford to purchase it outright – usually because they can’t qualify for the financing required. Both LTOs and LCs offer wannabee buyers the right to occupy a house for a period during which they can improve their capacity to qualify for the financing they need to complete the deal.” —Mortgage Professor
Near the end of the contract term, a balloon payment is usually made by the buyer to the seller. This completes the buyer’s financial obligation and the seller conveys the title to the buyer. In other words, you are entering into a seller financing agreement but the seller holds the title until the very end. This presents a serious risk because you aren’t the legal owner of the property. So, if the seller incurs some hardship or legal situation and a lien is placed against the property, you’re essentially out of luck. It could be due to a car accident, tax lien, criminal or civil legal trouble but it encumbers the property — so the title cannot be transferred.
About Lease-to-Own or Rent-to-Own
A lease-to-own, rent-to-own or lease option works a bit differently. In a lease-to-own or rent-to-own arrangement, the lease serves a dual purpose as a standard lease and as an option to buy. With a lease option, the seller will put part or all of the rent payments toward the final purchase price. A big benefit of a lease option or rent-to-own agreement is its ideal for buyers with poor or mediocre credit. Plus, you’re not typically not legally obligated to exercise the purchase option. So, if circumstances change, you can simply walk away at the end of the lease.
Here’s a little advice about land contracts and lease-to-own arrangements:
- Be cautious about non-traditional financing. Before you enter any type of non-traditional purchase agreement, it’s best to consult an experienced real estate attorney. You should fully understand the legal ramifications of various scenarios. Also, you need to be aware of the pros and cons.
- Look into other possible options. If you believe you do not qualify for a standard home loan, you should learn about your options. You will probably find there’s more available than you believe. Speaking with a mortgage broker is a good way to learn more about your options and alternatives.
- Always be realistic. Before you apply for a mortgage, take a careful look at your finances and credit. Generally, lenders prefer a debt-to-income ratio of under 35 percent but there are qualified mortgage products which allow a DTI of up to 43 percent.
If you’re considering buying a home and want to know about different purchase options, please don’t hesitate to phone me at 407-616-7286, I’ll be happy to speak with you.