What Are The Differences Between Rent To Own and Contract for Deed?
For home buyers who are learning what rent to own and contract for deed financing are for the first time it can be confusing to understand the differences between these two real estate contracts.
For these are the only two alternative methods to purchase real estate for home buyers who can not obtain bank financing. There are more exotic financing options for investors/non-owner occupied home buyers, but if you are simply trying to purchase a home as your primary residence rent to own and contract for deed financing are it.
Rent to Own
Rent to own financing is also known as: lease option, lease-to-own, option-to-purchase, rent with option to buy, etc. so don't get confused if you see similar names in other places on the Internet. As the name would suggest, you are renting the home with the intent to purchase it within a predetermined time-line (usually 1 to 3 years).
Virtually 95% of the contract is still going to be a standard lease agreement that renters are used to in Minnesota. This does mean credit matters very much as there will be an application fee where the landlord/property management company pulls credit. It is therefore important for tenants with credit issues to find out the landlord's qualification criteria as early in the process as possible.
The "option" part of the rental agreement is ultimately what makes it a rent to own, because the landlord and tenant agree to a purchase price when signing the lease agreement. For example, the tenant signs a lease agreement on a home they love with landlord and agree upon a purchase price of $200,000. At any time within the lease agreement (once again usually 1 to 3 years) if the tenant can obtain a bank loan they can go ahead with the purchase without having to renegotiate on price with the landlord.
Besides purchase price, the following are terms that the landlord may or may not choose to include in the option section of a rent to own agreement:
- An Option Down Payment - Instead of taking a security deposit and one month's rent like you would see in a typical lease; a landlord may choose to ask for a non-refundable down payment on the house that can range from 3 to 5% of the purchase price. As long as the renter goes ahead and purchases the home this down payment is still theirs, but if they fail to exercise their option and never purchase the home the landlord keeps this down payment.
- Monthly Rent Credit - A monthly rent credit is where a percentage of the tenant's rent is credited towards either the purchase price or down payment (tenant gets to choose). For example, out of $1600/month rent $150 shall be considered a credit. The landlord will still retain this during the lease agreement, and if the tenant fails to exercise their option to purchase the home landlord gets to keep the rent credit.
- Home Maintenance Responsibilities - Tenants in a rent to own agreement should be aware that most likely they will take on minor home maintenance responsibilities since the intent is still to eventually purchase the home. However, major structural items such as a roof should not be part of this as the landlord will be carrying homeowner insurance on the property. Make sure to read the fine print in the rental agreement to ensure there are no misunderstandings down the road.
Contract for Deed
Now that you understand what a rent to own contract is we can compare the differences with contract for deed financing, and in many ways these two contract could not be more opposites.
First and foremost, with contract for deed you are purchasing the home. Make no mistake about it you are the owner of property, will pay property taxes & homeowner insurance, and have full responsibility of the property maintenance. Instead of going to the bank for home mortgage the seller will finance you, or sometimes it is called owner financing.
The following are some other differences between rent to own and contract for deed:
- Down Payment is Much Higher - Since contract for deed is not a rental agreement there will be a down payment, which when subtracted from purchase price will equal your loan amount. It ranges from 10 to 20% of the purchase price.
- Credit Does Not Matter - One of the primary reasons contract for deed has a higher down payment requirement is because credit plays no factor in qualifying for a loan. It is a major difference versus rent to own since many home buyers have credit challenges that may disqualify them otherwise.
- Monthly Payment - Just like a bank mortgage the borrower in a contract for deed will have: an interest rate, amortized over a certain number of years (for example 30yr.), where principal & interest payments are made on a monthly basis. For home buyers who are tired of throwing money away on rent this can be an appealing difference versus rent to own. Also, in many areas around the Twin Cities, Minnesota area rental rates are higher than what your monthly payment will be with contract for deed financing. This can also be another major advantage to home buyers.
- Balloon Payment - A rent to own will have a lease period versus contract for deed that has a balloon payment, which is a way for the owner to set a date on when they want the borrower to satisfy the loan. The range can vary widely, but anything 1 to 5 years is normal in a contract for deed. For 99% of home buyers this will mean a eventual refinance into a bank loan as it will be unpractical to come up with that large of a payment.
The clear message with both of these real estate contracts is they are meant to only be short term solutions. Home buyers need to understand this going in, and make sure they are constantly working with mortgage lenders/credit restoration companies to ensure they can get eventual bank financing.
The data relating to real estate for sale on this site comes in part from the Broker Reciprocity program of the Regional Multiple Listing Service of Minnesota, Inc. Real Estate listings held by brokerage firms other than Bridge Realty are marked with the Broker Reciprocity logo or the Broker Reciprocity house icon and detailed information about them includes the names of the listing brokers. Bridge Realty is not a Multiple Listing Service MLS, nor does it offer MLS access. This website is a service of Bridge Realty, a broker Participant of the Regional Multiple Listing Service of Minnesota, Inc.
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Listing information last updated on September 26th, 2017 at 10:24am CDT.