Lease-Option Deals Have Plenty of Risk

Lease-Option Deals Have Plenty of RiskBy Robert Irwin Question: What is the nature of "rent-to-own" arrangements? Why are they done and what are the benefits for would-be buyers? -- Kimber, Flint, Mich. Kimber: Rent-to-own transactions are a fairly common way for buyers who don't have a lot of cash to purchase real estate. The typical way to arrange such transactions is as "lease-option" deals. Under a lease-option deal, the buyer agrees to rent a property for a period of time, typically several years, with the option to purchase it, usually at a set price, during that time. The tenant typically pays an above-market rent. (If the normal rent for the property is $1,000, he or she might pay $1,300.) But each month a portion of the rent (in our example, maybe $500) goes toward building a down payment. When the buyer accumulates enough money in the seller's account (after three years in our example, he or she would have $18,000), that money is credited toward the down payment. The buyer would then obtain a mortgage and exercise his or her option to buy the property. If all goes well, the person's tenancy changes to ownership. The advantages for the buyer are obvious. He or she is forced to accumulate money that will eventually be used as part of a down payment. More importantly, the person usually locks in a price upon moving in. With the recent run-up in real-estate values, this could make the purchase price a bargain when the deal closes several years later. Finally, as the tenant in what will become his or her new home, the buyer can be sure it is well taken care of. The disadvantages aren't as clear, but they are just as real nonetheless. Paying above-market rent might be difficult, sometimes impossible, depending on the person's financial situation. And if the would-be buyer can't afford to pay the higher rent and has to move out early, he or she will lose all the money that had already been paid as excess rent. In addition, the whole process usually hinges on the buyer's ability to obtain financing at the end of the lease-option period to make the purchase. But if the person's credit is somewhat tarnished or if he or she doesn't have enough income or is faced with a financial emergency, it could be tough to secure financing in a timely fashion. In such situations, the prospective buyer would lose the house and all the money that he or she had already invested. Some unscrupulous sellers enter into lease-option deals with no intention of completing the sale; they just want to collect above-market rent. Such being the case, these people try to find tenants who couldn't possibly keep making the payments. Should the tenant find a way to make the payments anyway, such sellers often try to make living in the property very uncomfortable after a few years. In some rare cases, a seller will even claim that the tenant never paid the extra money that was supposed to become part of the down payment. Under these circumstances, the tenant's only recourse might be going to court. Because of these risks with lease-option deals, buyers today often have a better alternative. With properties priced at around $300,000 or less, both Fannie Mae and Freddie Mac offer low-down and no-down financing arrangements. In some cases, buyers can get 103% of the purchase price and use the extra money to help with closing costs. Buyers who are short on cash and considering lease-option deals should contact a good mortgage broker and find out if they can get preapproved first. Taking this step shows people just how big of a mortgage they can obtain and how small of a down payment they will be able to make. Many buyers are pleasantly surprised to learn they can buy property without having to enter into a rent-to-own arrangement.-- Mr. Irwin has more than 25 years' experience as a Los Angeles-area real-estate broker. He is the author of more than two dozen books about real estate and is recognized as one of the most knowledgeable writers in the real-estate field. Mr. Irwin's most recent book is "Tips and Traps When Renovating Your Home," (McGraw-Hill, 2000).your question to [e-mail], with your first name and the city where you're located, which are required to publish your question. If your question is answered and posted, we will show your first name and city.Although we can't acknowledge all e-mail, we'll answer as many questions as possible.