ElaineMarie: What exactly is Rent to Own?
kev2006n: I would like to know more about rent to own?
It’s a fairly simple concept that’s been popular for years in Austrailia and parts of US. I’ll explain the basics here but for the benefit of the moderators I’ll stress I’m not trying to sell this to anyone as a product, I just see it as a great alternative, particularly for first time buyers. Please bear in mind I've cut and pasted this from another document (of my own) so some of the figures may be slightly out of date now and the formatting isn't ideal.
1. You find your desired property just as you would normally. Only difference is seller will be offering it as a “Rent to Own” either directly or through an intermediary with knowledge of how to process such a transaction (your average Estate Agent wouldn’t be geared up do this). Seller may be on market as normal or he may be advertising to let to tenant as normal, so will usually add ‘Rent to Own’ as a further option.
2. You’ll negotiate a purchase price just as you would normally and you’ll also agree a monthly rental amount (as you’ll be renting prior to owning it).
3. You’ll negotiate an ‘option’ period which could be any period you like, but typically will be between 2 and 5 years. So if it’s 5 years then you’ll have the exclusive option to buy the property outright at ANY time (to suit YOU or YOUR circumstances) within the next 5 years. The only condition is you must rent the property in the interim period until you are ready to buy it.
4. The prime advantage for the buyer is that they can choose their first home, precisely as they would in the “traditional” way, but they don’t actually have to buy it until just prior to the option period expiring (although they are completely free to buy it sooner if they so wish). There are many real spin-offs from this advantage such as –
(a) imagine a young couple, really excited etc at the outset but within 2 or 3 years things go a bit stale, or she gets pregnant, or he loses his job, or they find they don’t like the area, or they don’t get on with the neighbours, or the roof falls in etc etc. A multitude of possible scenarios and at the end of the day, if they want to end the agreement they just give a months notice as per the tenancy agreement and hand back the keys with no debts to settle or creditors to chase them. Just think for a moment how different the financial implications could be had they bought the property outright at day one and signed up for a fixed rate mortgage, and maybe the property could even be worth less than they paid for it. Any of this sound feasible?
(b) Many young people simply can’t afford the commitment of a mortgage on the amount they earn today, but those with career prospects (may or may not be new graduates) can see their earning power increasing rapidly within 5 years. Trouble is the market may have run further away from them by then. Sound familiar? So wouldn’t it be a good thing if they could reserve a property at todays price until they’re ready to buy it
(c) Many on good incomes are too young to have built up a healthy enough credit rating to enable them to get the most competitive mortgage products. They could secure something now, defer buying for a few years and save an excess amount towards a bigger deposit when the time comes.
(d) Foreign migrant workers choosing to settle in UK also come across similar credit rating issues which excludes them from the best mortgage deals. Deferring a purchase gives them time to build this up.
(e) Lots of divorcees come away with good financial settlements but poor credit rating due to a bad history through past defaults. As with the previous points, deferring the purchase gives them enough breathing space to be able to rebuild their credit profile.
(f) Plenty more scenarios but you get the picture I’m sure..
5. But why would a seller freeze the price at todays rate when he may be able to get a lot more in say 5 years time?
(a) The seller want’s to sell. If they sell today they’ll get todays price. If they sell in 5 years to someone who’ll rent continuously until then, they’ll have a guaranteed positive cash-flow for each month until that time comes. The seller has effectively got a guaranteed buyer lined up who’s willing to pay rent on time until such time as they can buy outright.
(b) The seller will charge an ‘Option’ fee to the tenant/buyer – typically between 3% and 5% of the agreed purchase price, which he (the seller) will keep if the buyer defaults on the rental agreement of fails to exercise the option to buy
6. So the prospective tenant/buyer has to pay an ‘Option’ fee?
Yes, because without that, the tenant/buyer would be no different to any “ordinary” tenant, in that he could simply stop paying his rent, trash the property and leave the seller high and dry. The option fee is really a form of commitment from the tenant/buyer and is usually (but not always) refunded (deducted off agreed purchase price) when the property sale is completed.
In some cases there may also be supplemental monthly payments above the rental amount and these would usually (but not always) be credited against eventual purchase price.
The object of the exercise is for the tenant/buyer to have sufficient funds in place to enable a purchase towards the end of the option period. If they are simply left to save that amount voluntarily then there’s a much greater chance of the plan failing. If on the other hand they make a formal commitment to pay either an ‘Option’ fee, enhanced rental amounts, or a combination of both, then that’s their commitment to making the plan viable and sustainable.
Consider a scenario of a tenant/buyer couple paying say a 3% option fee on a property worth £150k (so they’d need to find £4,500 up front). After 5 years if things don’t work out for them they can walk away having paid market rent (which they’d have paid anywhere else anyway) plus they’d have lost £4,500. Yes that’s pretty bad but not half as bad as a break-up with a new mortgage in tow. On the other hand, if the market moves in the right direction in that 5 year period (fingers crossed for 2014) the property could be worth a lot more than £150k so they can still sell their ‘Option’ to but to someone else.
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Finally, here’s a maths comparison for 2 identical houses side by side to give an idea on how the numbers compare between a "traditional" purchase and a sample 5 year ‘Option’ scenario –
Mr & Mrs Nervous buy their house today for the market value of £120,000
They pay a mortgage application fee (£250), a valuation fee (£250) and a Homebuyers Report (£600)
They pay a 5% deposit (£6,000), a Higher Lending Charge (£1,000), Legal Fees (£750) and take on a 95% mortgage for £114,000
They pay £769.74 per month towards a 25 year repayment mortgage at an interest rate of 6.5%
Finally, here’s a maths comparison for 2 identical houses side by side to give an idea on how the numbers compare between a "traditional" purchase and a sample 5 year ‘Option’ scenario –
Mr & Mrs Nervous buy their house today for the market value of £120,000
They pay a mortgage application fee (£250), a valuation fee (£250) and a Homebuyers Report (£600)
They pay a 5% deposit (£6,000), a Higher Lending Charge (£1,000), Legal Fees (£750) and take on a 95% mortgage for £114,000
They pay £769.74 per month towards a 25 year repayment mortgage at an interest rate of 6.5%
They pay a mortgage application fee (£250), a valuation fee (£250) and a Homebuyers Report (£600)
They pay a 5% deposit (£6,000), a Higher Lending Charge (£1,000), Legal Fees (£750) and take on a 95% mortgage for £114,000
They pay £769.74 per month towards a 25 year repayment mortgage at an interest rate of 6.5%
They pay £769.74 per month towards a 25 year repayment mortgage at an interest rate of 6.5%
In 5 years time, assuming a constant rate, they’ll have paid out £46,184 towards their mortgage, plus approx £8,850 for deposit and associated fees, so a grand total of £55,034
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Mr & Mrs Happy sign an ‘Option’ to buy the house next door, for £120,000 at any time over the next 5 years and agree to pay a 3% fee for the privilege (£3,600)
Instead of paying £769 mortgage like their neighbours, they pay £600 per month rent and they save £150 per month towards their future deposit.
In 5 years time, assuming a constant rate, they’ll have paid out £36,000 in rent, plus £3,600 for the ‘Option’ to buy at a guaranteed fixed price that was agree 5 years previously. In addition they’ll have £9,000 saved towards their mortgage.
In 5 years time Mr & Mrs Happy will be £24,434 better off than their nervous neighbours, having spent £15,434 less and with £9,000 in the bank.
Now Mrs & Mrs Happy are entirely free to choose whether to go ahead and buy their home (if it suits their circumstances at the time), or they can sell their guarantee to a third party for an immediate cash profit, or they can just walk away if they wish. This flexible choice will have cost them just £3,600; so even if they chose to walk away, they’d still be £20,834 better off financially than their neighbours.