Lease Purchase or Land Contract: Dangerous?
The American dream is still very much alive and owning a home is at the top of the list.
The recent changes in the lending environment have helped thousands of people with the ability to qualify for a mortgage that weren’t able to just a few short months ago. However, there are still hundreds of thousands of American’s that are still not able to obtain a home mortgage.
Many of the people that aren’t able to (or don’t think they can) qualify for a mortgage are exploring various ways of “owning a home”. A few of the most popular ways are, lease purchases, land contracts, rent to own or also known as RTO type homes. (all of these types are very similar to each other, but they do have some differences)
If you plan to enter into any of these types of transactions, I strongly encourage you to work with a Realtor that is familiar with the processes involved. As with any real estate transaction, you should have your own Realtor and not work with the home owner’s Realtor. A buyer’s agent, such as myself will protect the buyer’s best interests in a transaction.
The listing agent already has a signed agreement with the seller and has promised them they would sell their home for the most money. In addition to having your own Realtor, the paperwork for any of these transaction types should be prepared and executed by a real estate attorney.
When working with a buyer’s agent, rest assured that your best interests are protected by having your own representation and the seller is responsible for paying any real estate commissions.
A “lease with the option to purchase” simply means that a person is “renting” a home and has put down a “deposit” at the beginning of the contract giving them the “option” of purchasing the home for a “set price” at the end of the lease option term as outlined in the agreement between all parties. If the buyer does not exercise his/her “option” to complete the transaction, the parties part ways and any monies given to the home owner remain with them and the buyer walks away with nothing.
An RTO or “rent to own” transaction is very similar to a “lease with the option to purchase”.
Lease Purchase & Land Contract - What Could go Wrong?
A “lease purchase” is also very similar to a “lease with the option to purchase” transaction, but, if the buyer fails to complete the transaction at the end of the term as written in the legal agreement, the seller has the right to sue the buyer for “failure to perform”.
In any of the transaction types mentioned above, the home owner normally retains responsibility for any major maintenance items, the property taxes and the home owner’s insurance. The buyer is typically required to purchase and maintain “renter’s insurance” and be responsible for minor maintenance. Many contracts also state the buyer is to receive home owner permission for any changes to the home or property, including changing the color of the paint.
A small portion of the monthly payments may or may not be applied towards the purchase price of the home/property.
“Land contracts” sometimes contain language that a buyer’s name will be placed on the actual deed to the home/property.
The buyer then makes a monthly mortgage payment to the home owner, similar to a traditional mortgage. If the buyer defaults, the seller may have to exercise foreclosure proceedings, very similar to what a bank might do.
A land contract can be quite risky if the seller still has a mortgage on the property. Every mortgage contains a “due on sale” clause and if the seller’s mortgage company finds out the home is being sold on a land contract, the mortgage company might exercise the “due on sale” clause and demand payment of the mortgage in full.
With most land contracts, a much higher than normal interest rate is charged on the monthly payment, the buyer assumes full responsibility for the home/property including the payment of the real estate property taxes, home owners insurance, maintenance, etc.
In all of the transactions above, the seller’s typically maintain the advantage in the transaction. They often can sell their homes at an amount higher than what the traditional real estate market might bring. This is due to the law of supply and demand. There is not enough supply of “seller financed” homes available and the sellers may take advantage of this.
So, you have read this far and are wondering how these transaction types can be dangerous. Ask yourself a few simple questions and it might make you rethink the entire consideration of entering into one of these transactions.
- What happens if the seller does not pay the property taxes?
- What happens if the seller has undisclosed liens against the home?
- What happens if the seller stops making his/her mortgage payments?
- What happens if the seller refuses to repair or replace any damaged or broken major items?
- What happens if the seller does not continue paying their home owners insurance premiums and there is a fire or storm damage?
- What happens if __________? There's no end to what could go wrong.
Now it is time for you to decide, are the risks worth the rewards?
My advice is to wait to purchase a home until you can do it with a traditional mortgage and not seller financed. The selection of homes will be much greater and the risks involved with be much less! I am the type of person that will tell you what you “need to hear” and not “what you want to hear”. When you are ready to work with an honest and caring Realtor, let me know, I’ll be right here!