Monday, August 12, 2013

Michael Hathman Explains Rent-to-Own Pros & Cons

Rent-to-Own is a great way to home ownership.  But, the buyer must be committed to the idea and work towards homeownership.  Most of the time, lease purchases work better in theory than in real life and the main reason for the failure of most lease purchases seems to be credit related in most cases.

Establishing & Re-establishing Credit

Typically, would be buyers lack either the credit or time-on-the-job or career time (or all three) and these issues can be stumbling block to getting a home loan.  In many cases, the issue is credit-related most of the time.  In many cases, rent-to-own still may require a minimum FICO score to qualify with some investors and sellers.

Renters often as the question, "How can I get credit if I don't have credit in order to get it in the first place?"  That is the matter that often stumps most people.  Typically, re-establishing credit is literally 2/3 of the battle to having good credit.  Credit History accounts for the remaining third of that puzzle.  Here are some excellent places to obtain secured credit:

Re-establishing credit is critically important to securing a home loan.  As a matter of fact, it is the SINGLE MAIN determinate in measuring risk and whether the credit line has been paid "on time" or not.  Failure to pay the reporting debts (which report on your credit report) will show late payments, substantially lower credit scores and also will cause a decline to happen on a home loan application.  Mortgage companies who provide FHA loans are looking for at least 3 debts that are paid "on time" for 12 months and with no late payments showing.

This is how credit is computed as a FICO Score:

Disputing Derogatory Credit

Many times renters are plagued by collections, judgments, charge off accounts and late payments most of the time.  The best way is to dispute these items on the credit report.  As many credit reports contain erroneous information, disputing all derogatory credit is an excellent way to start healing credit report history.  Sometimes hiring a "Credit Coach" such as
I Rent To Own ( can be a great benefit to making credit report progress.

Settling Account Traps

Most people incorrectly believe that by "settling" an account improves credit.  It does not.  In fact, it damages and even lowers credit scores.  Why?  The creditor will update the credit report showing it as a paid collection.  This "renewing" of the account makes it appear as if it is a brand new derogatory account which reports to the credit report.  To make matters worse, the account starts the "time clock" all over again for the account to "fall off" the credit report - which normally is 7 years.

The best way to settle accounts is to settle for a fraction of the amount owed and to open a "settlement account" at a separate bank other than the bank where you are currently banking.  In this way, if a creditor where to find out where you bank and was to secure a judgment against the debtor, the debtor's main bill paying account should be out of harm's way from being placed under a judgment levy.

Furthermore, getting the settlement agreement in writing NOT OVER THE PHONE will help in getting settlement terms.  Far too many times debtors make settlement arrangements over the phone with a creditor and send in the "settlement payment" thinking the account has been settled.  The company "applies" the payment to the account as a "partial payment" and because the "oral agreement" was not honored, the debtor gets stuck with paying on the account again in order to settle it for even more money.

Additionally, many debtors don't forget to ask to have the account deleted from the credit report as part of the settlement arrangement.  Sending in a settlement check with a restrictive endorsement that includes a deletion clause is a great way to ensure that the settlement was made with the deletion agreement in place.  A copy of your cashed check will serve as your "paid" receipt.

How Rent-to-Own Works

Typically a seller would give a renter a chance at becoming a homeowner.  In a weak market where credit is tight and sellers can't sell, rent-to-own allows a seller to potentially sell his real estate to a potential buyer.  Part of the rent would be credited toward a down payment in order for the buyer to "save" and ultimately buy the home with the help of rent credits.

The time period allows renters to rebuild credit and get the needed time-on-the-job in order to qualify for a loan.

The Rent-to-Own Risks

Risks are present on both sides of the rent-to-own contract:

(1)  The seller could end up with a "deadbeat" tenant who doesn't pay the rent or is really motivated to buy the property.  Hopefully, the seller would not have to evict and the tenant will part in exchange for not being sued for rent and possession or unlawful detainer.  A deadbeat tenant can also cause a seller to lose the house in a foreclosure proceeding.

(2)  The tenant could damage the property or abandon it and the seller may need to do repairs and cleaning to get it back on the market again.

(3)  The seller could stop making mortgage payments to the bank in the lease term and the house could fall into foreclosure.  The seller would not only lose the house along with any equity that has been built up therein but the renter may also lose any down payment and deposits that were paid to the seller as part of the rental arrangement.  Sometimes this can happen if the seller dies, becomes disabled/incapacitated, unemployed or simply quits caring about making the house payments.

Qualifying for A Home Loan

Qualifying for a home loan is fairly straight forward.  As of 2013, most lenders are seeking purchasers who have a credit rating of 720 for a conventional loan and 640 for an FHA loan. Since most renters face a tough task of qualifying for a home loan, the 640 credit score is much easier to achieve.  Here's what a renter will need to do:
  • Have a credit score of over 640.
  • Have at least 3 trade lines established on the credit report with no late payments.
  • Have steady employment on the job or in the same career field for not less than 3 years.
  • Should not have a foreclosure or bankruptcy reporting in the last 3 years.
  • Be able to choose a house with a payment that will not exceed 29% of the renter's payment.  This will include principal, interest, taxes, insurance, association dues (if any) and the rent premium for the landlord.
  • Renter's total debt should not exceed 41% of the renter's gross income including the house payment.  This would include any and all debts, credit card payments, car loans, installment debts, etc.
  • Have a bank account with no negative account balances for the 3 months that precede loan application.
  • Have reliable phone so the loan officer (or underwriter) can verify residence as well as reliable contact information such as a cell phone number and/or e-mail address.

Tips on Rent-to-Own

(1) Sellers should know everything they can about the renters.  This includes:
  • Getting a complete Residential Rental Application;
  • Getting at least 4 copies of paycheck stubs;
  • Checking public records for evictions, criminal background history;
  • Getting a copy of a credit report;
  • Getting a copy of a driver's license;
  • Getting information on the cars they drive.
(2) Renters should get a complete home inspection and also complete a walk-through checklist prior to entry and exit.

(3) Seller's should obtain down payment funds prior to the renter taking possession.  Normally, allowing the renter to use first, last and security deposit as a down payment does 2 things - it helps protect the owner and offset costs should the renter bail out of the lease to pay for the costs of showing and re-renting and it will give the renter a sense of ownership.  Of course if the renter does not complete the sale, the down payment should be forfeit.

(4) The owner should set some guidelines about expectations.  For instance, certain conditions must be met in order that the purchase work such as:
  • The renter is not to change employment or change jobs unless it is in the same career field;
  • The lease payments are made on time and without delay;
  • Renter shall make prompt payments and refrain from making any partial payments;
  • Renter shall sign an ACH Payment Authorization Form so landlord can debit the renter's account for payment if possible.
(5) Set the purchase price up front upon signing the lease and purchase agreement.

(6) Seller should be clear on maintenance issues.  For example, a landlord may insist that the renter pay for all repairs up to $150 for each repair.  Any repair exceeding $150 the landlord shall be responsible to pay the balance.  There should also be a provision for lawn maintenance and if the renter cannot pay for a pressing repair, what the provisions would be for landlord paying and that it would be added onto the renter's next monthly renter's payment.

(7) Seller should make a "Seller's Disclosure" to the Buyer/Tenant.  These disclosure include (but may not be limited to):
  • Lead-based paint;
  • Mold;
  • Flood plain;
  • Conditions of the home.
(8) Buyer should insist that the seller set up an independent mortgage collection and payment account to ensure that the mortgage is being paid on time and for the purposes that the house will not be falling into any type of foreclosure proceedings.

In Conclusion

Rent-to-Own is a great way to establish homeownership.  It can and does work very much as a lease and also as a purchase transaction.  As long as the parties understand the parameters of what needs to done during the leasing and sales process, the transaction can and will be a success.

Reporting for Real Estate News Now,
Michael Hathman