Is Owner Financing Like Rent To Own? Exploring Distinctions

Rent to Own

Rent to own was one of my favorite ways to buy houses and sell houses when I was getting started at the ripe age of 21.  Being able to focus on both price and terms of a transaction opens up tremendous opportunities.  Both rent to own and owner finance are fantastic tools for real estate investors.

What Is A Rent To Own?

Rent to own is another way to say lease option.  Rent to own combines a lease or rental agreement with an option giving you the right to buy the house. Typically, you will see monthly rent payments with a small portion applied to purchasing the home, and a term for you to exercise your option to buy.

Pros And Cons Of Rent To Own Housing

Pros – The great thing about rent to own is it is simple to understand so it is easy to explain to both tenants and sellers.  As a buyer, it allows you to control property with very little or no down payment.  As a landlord, it helps get quality tenants and top value.

Cons – There are not too many cons, especially as a buyer.  You will not have much or any money down so your risk is limited.  Because you are not the owner it could complicate some tasks like insurance claims and there is always the chance that the seller changes their mind about selling.  That is why you would want to structure your deal to protect yourself from that.  As a landlord, the one downside is that if the home goes way up in value, you will be locked in at a much lower price.

What Is Owner Financing?

There are many ways an owner of a home can carry financing.  If the property is free and clear they might carry the entire thing with a note and a mortgage.  They may also do a second mortgage behind a new first mortgage to help with your down payment.  Any time a seller participates in your funding it is considered owner financing.

Pros And Cons Of Owner Financing

Pros – As a buyer of investment property, owner financing will limit your out of pocket costs.  Owners are typically much easier to work with than banks so you may be able to get more favorable terms, and there is much less qualifying.  It allows non-financeable buyers to buy houses.  As an owner, it helps create value in the transaction so you can charge more for the house and the deal should also produce some passive income.  You will be secured with your investment in the house so you can keep your money safe.

Cons – The cons with owner finance really come on the seller’s side.  If there is a default, you will be forced to foreclose instead of evict.  Foreclosure is a much more challenging and expensive process.  It is this reason that I would always suggest getting a large enough down payment to handle a default, and be prepared to foreclose if needed.  As a buyer there really is not much downside.  There is a chance your terms will be worse than you would get with a more traditional lender, but even that is not too terrible.  You will know the terms going in and there is always the option to refinance the loan if needed.

How They’re Similar

Both rent to own and owner finance allow buyers to get into homes with little to no help from banks.

Method Of Acquiring Property

Both are just one more way real estate investors buy houses.  Because they are non-traditional methods, investors see tremendous flexibility.  Both are often used by buyers that cannot get traditional bank loans.  When I started in the business my credit was great, but I was working part-time while attending school.  I did not make enough money to qualify for loans but I was able to buy a house or two month after month using these strategies.

Suitable For Individuals With Bad Credit Standing

Although I had good credit, many real estate investors do not.  Using either one of these strategies gives you time to improve your credit and get a traditional loan.

Down Payment Requirements

Typically you can do rent to own structures with very little to no down payment at all.  In fact, there have been times I have had sellers pay me to enter into an agreement.  It is much more common to see down payments with seller financing, however. Because title actually transfers, sellers will likely want some kind of down payment, but it is still probably much lower than you would get with a traditional lender.

How They Differ

These two strategies are very similar but there are some differences.

Official Transfer Of Ownership

With a rent to own you are typically signing an option to buy.  An option is not an obligation so you will have some flexibility if you want to close on the house or not.  This is tremendously valuable in a time when home values decline.  Owner financing is great too because you will actually own the home, meaning you will get all the tax advantages of the owner.  The biggest difference in these two strategies is if ownership officially transfers.

Degree Of Risk Involved

As mentioned above there are times when not owning the house is much less risky.  This was very true for me as I navigated the credit crisis in 2008.  It is also safer for the owner.  If for some reason I defaulted on a rent payment, the owner could simply evict me which takes about 5 weeks in Colorado.  If I was the owner, they would have to foreclose, which is 5 months if everything goes smoothly.

Mortgage Payments

Mortgage payments can be tricky with rent to own because there are a lot of ways to do it.  For example, I had one where the mortgage payment was about $200 per month higher then I was paying in rent.  In this case, I wrote a check payable to the bank and sent it to the owner.  He then included his check and sent them both to make the payment each month.  It is very common for the tenant in a rent to own transaction to pay the mortgage company directly.  I preferred that so I knew the payment was made but I had some sellers where my payment exceeded their mortgage. I made the payment to them and let them pay the mortgage company.

For most owner financing, the buyer will pay the payment directly to the seller each month.

Maintenance And Taxes

Taxes will always be the responsibility of the owner.  If the owner has a mortgage where taxes are collected each month by the mortgage company, the mortgage company will make that payment but that does not change the fact that the owner is responsible.  Maintenance can be a tricky topic.  Typically when I buy using rent to own, I ask for the owner to step in and help with some maintenance items.  That is probably not possible with owner financing since the property has been sold.

Which Route Should  You Take?

This is a question each investor must answer for themselves.  As described, there are pros and cons for both.  For me, I always tried to get a title to the house because I was more comfortable knowing I owned it.  If the sellers were not in agreement, I would fall back to the rent to own.  The rent to own feels much safer to sellers since they still own the house and is easy to explain, making it a perfect strategy for the cautious motivated seller.

Still unsure which option to take to finally get that property you’re interested in?