In last week's column, you read about the benefits and risks of owner-financed transactions from the seller's point of view. This week we'll examine how to structure an owner-finance offer from a buyer's perspective and some tips on successful lease-purchase arrangements.
Who needs seller financing? Most people think that it's for those who have damaged credit, or could not otherwise obtain conventional financing. That may be the case, and if indeed you have some credit issues that require seller financing, be prepared for the following terms.
If you simply have scattered consumer late payments (credit cards and installment debt), say more than 10 over the past 2 years, a lender may offer a mortgage rate 2 to 3 percent above market rates. Today, that would result in a mortgage rates of 8.5 to 10 percent. If you also have late rental payments, expect an even bigger hit.
However, there's a lot to be said for potential home buyers who have had late payments on other items but kept their sacred rental payment on time, every time. That can say a lot when it comes to explaining to a potential seller that "yes, there were some bad times, but we always paid our rent on time!" Be prepared to provide the seller both your rental agreement along with 12 months worth of canceled checks showing timely payment.
By being up-front about credit issues and demonstrating that negative items were due to a particular event, such as illness, loss of job or other catastrophe will go a long way -- especially if your rent was always paid on time. Another plus...if your new house payment is close to your rental payment you can make a case that you've established the fact that you can afford your new home, just as you afforded your rent.
But if your credit is excellent, why would you ever need owner financing? Sometimes the property itself is a concern, regardless of who the buyer is.
When a lender issues a mortgage loan, the lender attempts to justify the sales price by looking at similarly priced houses of similar size in the immediate area. Sometimes this doesn't happen because the structure is unique, say a log cabin, A-frame or geodesic home. Or, comparables may be difficult for a property located in a secluded area miles and miles from like structures or recent sales. If this is the case, then you may want to make a purchase offer with the seller financing all or most of the mortgage.
Would an offer with seller financing be attractive to an owner? No always. But what if financing from a conventional lender is unavailable and a buyer with cash is not to be found? In such circumstances, an owner "take-back" may be attractive.
If you can find a seller who will provide part of the financing, then lenders may be more easily convinced to provide either a first or second mortgage on such unique properties. Between financing from the owner and a loan from a lender, you'll need fewer dollars from your bank account.
Lease purchase plans can be a good idea for selected buyers who don't have enough money down for a conventional loan or who need some time to both save money and establish credit.
A lease purchase is an agreement between a buyer and owner under which the owner gets rent and the buyer has the right to purchase the property at a given price by a certain date. Lease purchases can be attractive for both buyer and seller, but the financing with many lease purchases is set up incorrectly, making them difficult to finance at the end of the lease period. To avoid the big pitfalls, follow these steps:
- If part of the rent payment is to be set aside each month for a future down payment, the owner must agree not to commingle the funds. In other words, the seller should establish an "escrow" account specifically for your money. That way, when an underwriter reviews your loan application, there is no doubt as to whose money belongs to whom.
- Is part of your monthly rent also going toward the downpayment? If yes, then the monthly payment must include your lease payment PLUS your extra money. Only funds above market rent may be included in your savings account.
What's the "market rent?" It's an amount determined by having an appraiser perform a market rent analysis at time of contract. Why? If you don't pay above and beyond market rent, then the seller is in effect "giving" you down payment money. While there may be exceptions, in the general case a conventional lender will only credit monthly rental funds to your downpayment if they are above the market rent.
A clean, no-questions-asked lease/purchase agreement could work like this: If the market rent in your area is $500 per month and you want $100 each month to go toward the down payment at the end of your lease, then your total payment would be $600 per month. Of this amount, the seller should put your extra $100 in an escrow account. Structured this way, you won't have a "savings surprise" when it's time to buy your new home.
The rules relating to lease purchase agreements vary by jurisdiction and such agreements can be complex. Both buyers and sellers are best served by each having an attorney review such agreements before either party signs and also by speaking with brokers and lenders.
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