Sunday, June 7, 2009

The Return of Owner Financing

When banks were handing out money with 100% financing and going light on credit checks, owner financing (aka "rent to own") fell out of fashion. As credit and the need for down payments has tightened, demand for owner financed lease arrangements has increased sharply.

There is a risk element involved with leasing of a home, so good tenant screening and some form of landlord insurance is important. That said, homeowners who want/need to move and have enough equity in their home may be able to take advantage of this demand and weather this buyer's market a bit better than most. Following is a brief overview of common lease arrangements and some of the pros and cons (as always, you should seek professional legal and tax advice to evaluate your personal situation).
  • Lease/option - this is what most think of as a "rent to own" arrangement. The buyer/tenant pays for the right to purchase the home within an established time (e.g., within 1 year) at an agreed to price. If the buyer chooses not to purchase the home within that period, then they usually forfeit the "option fee" to the seller. Depending on how agreements are setup, the option fee, and possibly even a portion of the rent, may be applied to the down payment at time of purchase. A common element in a lease/option agreement is that the seller is relieved of the property maintenance since it is assumed the buyer will exercise the option.
  • Lease/purchase - a step above a lease/option, this arrangement requires the buyer to write a purchase contract that must be executed within a set period of time. This is probably the most preferred method by sellers since the buyers would perform any inspections and complete negotiations on the sales contract up front. As with the lease option, a deposit is usually setup as part of the down payment, but is forfeit if the buyer defaults on the agreement.
  • Land contracts - this is owner financing in its purest form. Essentially, the seller is acting as the bank and holds a note for buyer, charging a set interest rate for a certain period of time. In Ohio, the buyer gains equity in the property while the seller holds the deed. Notably, this form of financing can be a bit more complex from an accounting and tax perspective, but may also hold advantages for both the buyer and seller.
  • Renting/leasing your home - For those who have the opportunity to use their current home as investment property, this option can provide a nice income for those who are relatively handy and can handle routine maintenance calls and tenant screening (or are able to pay a property manager to handle these actions). This option may have an added advantage that owners can rent their home until such time that market demand and home prices stabilize.
One point to note is that most lenders will accept lease payments as income when trying to qualify for another loan. However, in the current lending environment, the restrictions may be tighter and require the lease to be "seasoned," i.e., already in place for 6 months to 1 year, before they use it as part of your qualifications.

While owner financing receives mixed reviews from real estate agents (mostly due to the fact that sales commissions are delayed at best, and lost through default of the buyer at worst), they nonetheless have become a factor in the current housing market. Anyone looking at selling a home in this market may want to consider this approach in the marketing of their home.

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