A mortgage is one of the most popular ways to finance a home. However, many home buyers fail to meet the stringent lending requirements associated with mortgages. Rent-to-own and owner-financing are two alternatives you can choose from to purchase a home. Although they are similar in numerous ways, it’s unbelievably easy to confuse one from the other. Both solutions offer a viable solution for people with bad credit to own a home, even with their significant differences.
We’re going to look at a rent-to-own vs owner financing comparison to help you understand better and pick an option that suits you best.
What Is Rent-to-Own?
A rent-to-own contract provides a renter with the option to continue renting a property while providing them with the choice of buying the same property at a specified time in the future. It’s an excellent option if you have a bad credit score or lack enough funds to purchase a home upfront.
The buyer is typically allowed 1 to 3 years to pay the agreed amount in full. Although the renter has the option of buying the home at a later date, they are not obligated to make the purchase, either. In this type of agreement, the seller retains full property rights until the renter keeps their part of the agreement in full.
What Is Owner Financing?
In an owner-financing agreement, the home transfer happens at the beginning, where the buyer automatically becomes the new owner of the property. The agreement allows the buyer to pay the previous owner in installments that can extend to several years.
With owner financing, the buyer continues paying for a transaction that has already happened, unlike in a rent-to-own contract where the buyer makes payments to a hypothetical purchase that might never materialize.
Key Differences - Rent to Own Vs Owner Financing
1. Transfer of Ownership
In a rent-to-own home agreement, the buyer rents the property for a specified period until they can find a way to purchase the home (either in cash or a loan from a lender). Transfer of ownership happens after the fulfillment of the contract. In an owner financing contract, the seller provides the buyer with a home loan, which gets paid in monthly installments until the whole amount is completed. Transfer of ownership takes place at the beginning of the contract.
2. Repairs
Given that in a rent-to-own setting the buyer remains a tenant until the home’s payment is completed, the seller retains all the rights and responsibilities of homeownership, including repairs. In an owner financing situation, transfer of ownership occurs at the beginning. Thus, the buyer assumes full rights and obligations of the home, including repairs.
3. Risk Potential
Buyers of rent-to-own arrangements don’t have the option of selling the property to avoid foreclosure since they don’t own the home. Also, deposits made in rent-to-own agreements are non-refundable if a default occurs. In owner financing agreements, the buyer can sell the property to counter default, where they would retain the property’s equity, which is subject to the sale price.
Advantages of Rent-to-Own
For Buyers
- Favors buyers with bad credit – it’s an ideal option for buyers with bad credit that can’t secure conventional financing. The prospective buyer can work harder to improve their credit score over time and probably secure a traditional mortgage to buy the property.
- Preset the purchase price – with ever-increasing home prices, the buyer gets into a contract to buy the home at the current market price for a purchase that will happen a few years later.
- Test the home – buyers continue living in the property and have ample time to decide if it is an ideal match for them.
For Sellers
- Provides better marketing since you can market to renters who might consider buying in future.
- You earn income before you decide to sell the property
- This option provides a higher sales price due to the flexibility it offers
- If the buyer defaults on their mortgage payments, you get to keep the all the payments made by the buyer and still keep the property
Disadvantages of Rent-to-Own
For Buyers
- You risk forfeiting your money. If you don’t buy the home in the end, you risk losing all the extra money paid.
- You have less control of the property since you don’t own the home. You may lose the home in a bank foreclosure due to missed mortgage payments by the seller.
- Home prices might fall, making you end up with an unrealistic investment.
- You might come to know about some issues with the property when it’s too late. You need to take due diligence when making long-term investments such as buying a home.
For Sellers
- There’s no certainty that the renter will buy the property. Nonetheless, the seller gets to keep the extra money.
- Slow and little payments that might not be enough for the seller to buy their next property.
- Missing appreciation for the seller since they are typically stuck in a preset sales agreement that can’t be changed whatsoever.
- The buyer might discover defects that you never knew existed and decide not to make the purchase.
Advantages of Owner Financing
For Buyers
- It’s a faster closing option since it doesn’t need a legal process or a bank loan officer
- It’s cheaper since it doesn’t need an appraisal or bank fees
- Provides a flexible down payment
- An ideal option for buyers who can’t get home financing
For Sellers
- Option to sell the property without making adjustments that conventional lenders might need
- It’s a good investment that can earn you better rates than if you invested the money elsewhere.
- The promissory note can be sold to a financier, providing a lump-sum payment, immediately.
Disadvantages of Owner Financing
For Buyers
- Higher interest rates than a traditional mortgage from a bank, meaning higher monthly payments
- Make sure the property does not have a bank’s due-on-sale clause. If it does, the bank can demand immediate payment once you become the owner of the property, leading to foreclosure.
- With most owner financing contracts, a large balloon payment matures in 5 to 10 years. If the buyer fails to secure financing by then, they risk losing the money paid up until that point, including the house.
For Sellers
- Under the Dodd-Frank Wall Street Reform and Consumer Protection Act, balloon payments may not be an option for sellers. The seller might need the services of a mortgage loan lender, depending on the properties they owner-finance annually.
- The buyer could default on the monthly payments, forcing the seller into the foreclosure process.
- If the buyer defaults and the seller takes back the home, they may end up paying for repairs and maintenance if the home is damaged.
Final Thoughts - Which Option Is Best
Rent-to-own and owner financing can be excellent home ownership options in ideal conditions. Keep in mind that both options possess risks that need to be assessed carefully before making any deals. If you are considering any of these options, it’s in your best interests to work with an experienced real estate attorney who can represent you during legal proceedings, inspections, appraisals, and make sure your rights are fully protected.
FAQ
In a word, NO. Owner financing and seller financing are one and the same thing. This is because in most cases, the owner is the seller.
Do you need to pay a down payment with owner-financing?
In most cases a down payment is required with owner-financing. However, the major advantage over a traditional mortgage is that the down payment is flexible.
In other words, you don’t necessarily need to meet the minimum down payment that a traditional mortgage would require. For instance, the owner may agree to a 5% down payment, in exchange for a higher interest or similar benefit that can be built into the contract.