Rent to Own vs. Seller Financing | Pros, Cons, and Mistakes to Avoid

If you’re considering buying a home, you might be totally overwhelmed by all the options and requirements out there. However, it’s important to never get discouraged. No matter your background and situation, there are things you can do to achieve the American dream of homeownership. For example, you could look into unconventional options like rent to own or seller financing. Both of these are solid options for people looking to purchase a home who might not meet the strict requirements of conventional mortgage loans . 

What Is Rent to Own Financing?

Rent to own financing is when the renter has the option of buying the house they’re renting from the seller at some point in the future. Until such a time, the renter continues to rent, and the landlord maintains ownership of the home. This arrangement involves a contract that contains the current sale price of the property, the amount of rent going towards that sale price, and the amount of time it can be rented before purchasing. Rent to own financing is a great option for people who have found a great home but aren’t yet able to secure financing or a big enough down payment actually to purchase the property outright.  All that being said, it’s important to note that a rent-to-own agreement does not obligate the renter to purchase the property at all. However, most rent-to-own agreements come with a large down payment to show future intent to purchase. This amount is typically much higher than the standard rental security deposit of one month’s rent and may also result in paying higher monthly rent costs than you would otherwise pay within a normal rental agreement. 

What Is Seller Financing?

Seller financing, otherwise known as owner financing , is similar to rent-to-own financing but has some key differences. For starters, in seller financing, the property changes hands after an agreement has been reached. However, the new owner continues to make payments directly to the sellers rather than a lender such as a bank or other financial institution.  Essentially, the seller agrees to act as the bank and finance the purchase of the property. The buyer’s payments go directly toward the loan amount of the property. The buyer is also required to make some sort of down payment, although the amount is typically lower than that required of a conventional mortgage. As a result, seller financing is a realistic option for buyers who have a poor credit history or an insufficient credit history to qualify for a conventional mortgage loan. 

What Are the Pros and Cons of Each?

The obvious pro of these options is that they allow more people the potential to purchase a home despite poor or nonexistent credit histories. Big banks usually have stringent loan requirements that make it nearly impossible for people to qualify who have past evictions, foreclosures, or bankruptcies. However, seller and rent-to-own financing allow you to bypass the big requirements of big banks. Rent to own financing allows the buyer to live in their perfect home while they save up the down payment amount needed actually to purchase it. They also have time to build up their credit and potentially qualify for a traditional mortgage. Seller financing allows the buyer to take ownership of the property immediately and enjoy more freedom when it comes to maintenance, renovations, and improvements.  That being said, these financing options also come with some disadvantages that need to be discussed. For example, in a rent-to-own agreement, the buyer is generally unable to recoup any of the costs that they put towards the house if they are ultimately unable to buy it. Furthermore, in a rent-to-own agreement, the buyer is depending on the seller to maintain the home and continue to make payments on it to avoid foreclosure.  Seller financing can only occur if the original owners do not owe any money on their mortgage and own the home outright. In the event that the buyer is unable to make mortgage payments, the sellers will need to begin foreclosure proceedings. Additionally, the buyer in this scenario is responsible for all maintenance, fees, and taxes that come with the property. 

Mistakes to Avoid When Considering Unconventional Options

Rent to own and seller financing can be considered high-risk, high-reward scenarios. However, one way that you can limit your risk and maximize your reward is to work with a qualified and reputable real estate attorney to help guide you through the process. An attorney can make sure that any agreement is accepted by all parties involved. They can help you draw up a comprehensive contract that includes all pertinent details and liabilities.  Occasionally, rent to own or seller financing scenarios actually end up being scams that simply take your money and give you nothing in return. For this reason, we always recommend doing your research and locating the title and tax record for the property to prove actual ownership. Once again, working with an attorney can help you identify potentially problematic clauses in the agreement that could leave you high and dry.  At the end of the day, investing in a lawyer when using rent-to-own or seller financing methods is a solid investment that protects you and your money. 

How to Improve Your Likelihood of Traditional Mortgage Approval

If you feel like you have no other choice than to go with unconventional methods to purchase a home, that might not be the case. Even if you don’t qualify for a traditional mortgage now doesn’t mean you’re permanently doomed. In most cases, there are steps you can take to improve your likelihood of getting approved for a traditional mortgage. Obviously, this transformation won’t happen overnight and will take time and diligence, but it will be well worth it in the end when you can finally purchase your new home.  Here are some things you can do to help you qualify for a traditional mortgage: 

• Improve your credit score: Having a low credit score is one of the biggest impediments to getting a mortgage loan. It will be nearly impossible for you to get a loan if your credit score is below 620. That being said, even if you have a score of above 620 and get approved for a mortgage, you will likely be paying a ton of extra money due to higher interest rates. As a result, we recommend having a credit score of 760 or greater in order to get the best interest rates and save money over the course of your loan.
• Increase your income: This solution is easier said than done, but it can increase the likelihood of receiving a mortgage loan since lenders calculate your gross monthly income and use that amount to qualify you for a mortgage. Lenders will often require two years of steady full-time income in order to qualify, and things like self-employment or part-time work are often not enough on their own. Whether it’s changing companies for a better position or getting promoted within your current company, maximizing your income is a great way to guarantee better mortgage terms.
• Pay off debts: Another difficult option involves paying off your debts as much as possible, as lenders calculate your debt to income ratio (DTI) and use it to qualify you for a mortgage. This is especially true if your debt is considered “bad debt,” like credit cards. However, even “good debt” like student loans plays into your DTI, so it’s always a good idea to pay off as much as you can before applying for a mortgage.
• Save your money: Finally, the last thing you can do to help you qualify for a traditional mortgage is to save enough money to make a sizable down payment . Not only will this decrease your overall mortgage amount, but it will make you less of a risk for lenders as a result of a lower loan to value (LTV) ratio. Generally speaking, it’s recommended that you save 20% of the home’s value to use as a down payment. 

Final Rundown

If you don’t qualify for traditional home loan financing, don’t fret -- there are still options out there that can make your dream of homeownership a reality. That being said, before you jump the gun and pursue these untraditional options, it might be worthwhile to take steps to improve your creditworthiness with the end goal of qualifying for a conventional mortgage. Even if you choose to go a different route along the way, improving your financial situation is never a bad thing and can benefit you in many other ways. If you have found yourself only more confused about your home financing options, reach out to the lenders at Seek Capital to get expert advice tailored to your unique circumstances.  Sources: https://www.forbes.com/advisor/mortgages/conventional-mortgage/ https://www.nytimes.com/wirecutter/money/how-to-build-credit/ https://www.cnbc.com/select/easy-tips-to-help-raise-your-credit-score/