Because homeownership is often less expensive than rent, we could see some of our rent-to-own tenant buyers start trying to execute their options. If you don’t have tenant buyers, you may want to consider using them for your rental property. You will generally get more rent and less hassle. In my experience, less than 20% of tenant buyers end up buying the home, but for me, I am happy when they do. I like getting a large payday, with no Realtor fees that I can roll into another deal. For this reason, I want to be sure my lease option documents are prepared correctly, to help their chances of getting a loan.
There are many effective and valid ways to structure a lease option transaction, depending on the parties involved and the objectives in mind. What a lot of sellers and buyers often overlook is that one of the most important “parties” to this transaction is the underwriter on the buyer’s loan, when the time comes to exercise the option.
One of the most important things to know about today’s new underwriting climate is that the tolerance for inaccuracy is down to almost zero. Much like I would recommend a good attorney review your documents, I think it is crucial for a good mortgage broker or banker to do the same.
Here are ten helpful hints to ensure the tenant buyer’s loan closes:
Rent credit should be allowed to be used towards the buyer’s down payment or minimum borrower contribution only if the rent actually charged does not exceed the fair market rents in that neighborhood. It is actually best to write your agreement that the rent credit reduces the purchase price and is NOT considered down payment. If they need the additional down payment, you may be asked to prove the rent credit is equal to the amount they paid above market rent, which is not going to be an easy task.
Fair market rents will be determined by the appraiser in the subject property’s appraisal report.
Credit for down payment must be accrued for a minimum of 12 months.
It is best to get as much money upfront as possible because all of that can be credited as down payment. You can reduce the amount of money the tenant buyer needs by offering to pay their closing costs. This could also be part of the rent credit, if it is structured correctly.
The lender will require a copy of the rental / purchase agreement evidencing a minimum original term of at least 12 months, clearly stating the monthly rental amount and specifying the terms of the lease.
The lender would like to see that the lease agreement references the purchase option and vice versa, or they are contained in a single contract, so the underwriter can have documentation of both aspects of the transaction. I have my option reference the lease but I want the lease to stand on its own; so for me the lease is a separate agreement that does not reference the option. This is how most attorneys would suggest you do it, so it is a good idea to run your contracts by a competent attorney AND a mortgage professional.
In no case should the seller ever comingle the borrowers rent credit, purchase option deposit, or security deposit with their own personal accounts.
Any rent credits, option payments and security deposit funds should be thoroughly documented to include copies of the original checks, copies of the cancelled checks, and copies of the account statements showing their entrance into and retention in those accounts.
Lenders will require copies of the buyer’s cancelled checks or other proof of payment for the last 12 months evidencing the rental payments. Be sure the tenant knows this if they are paying with money orders.
Sweat equity is normally not an acceptable source of funds or credit, only actual monies paid as outlined above, so don’t count on the buyer “earning” their down payment in lieu of rent payments.
Taking the above measures should help ensure a successful closing if your buyer can still qualify in all other required areas. With that said this article is not meant to replace a competent mortgage professional. Please visit our recommends page for a list of vendors we would recommend.