Last year, more than one hundred clients approached us to talk about potentially doing a Rent to Own deal with Blue Ribbon. The vast majority of inquiries went something like this: “My spouse and I are interested in looking at Rent to Own for our family. We’d like more information. Can you please tell us what the monthly cost would be and how it works?”
Almost everybody is fixated on what the monthly rent will be, and while that is very important it’s really not the first question you should be asking if you’re considering Rent to Own for yourself. Tenants and homeowners alike are concerned with the monthly outflow of money because it affects affordability and lifestyle. But homeowners also have another key focus: How much will it cost to buy the house?
In a typical real estate transaction, you locate the house you’d like the buy and then you negotiate with the vendor to get the best possible price. The house price is not an incidental consideration; it’s critical. The bank takes a very keen interest in the purchase price because the latter must match your ability to pay. That is, does your net income support the price you will pay? Can you afford all of the costs related to carrying a mortgage and maintaining a house? Lenders have specific income-to-expense ratios that must be met. If you exceed their ratios, then they won’t lend you the money for the purchase.
In Rent to Own, potential clients are so focussed on the monthly cost that they typically neglect to ask about the ultimate purchase price of the house. And yet, that number drives both the monthly costs and their ability to successfully complete the deal at the end of the RTO term. It also lets you know what appreciation rates have been used. Are they realistic? Do they fit the range and pattern for the specific area in question?
When you set out to evaluate a Rent to Own company, one of the first questions you should be asking of them is: What appreciation rates do you use for Area X? What specific data did you use to determine those rates? What will the final purchase price be at the end of the term?
Here’s the problem: If the appreciation rate is too high, then the house will not appraise at the end of the term and the lender will not lend beyond the appraised value. That means that in order to successfully complete the Option to Purchase, you the client will have to come up with the difference between the bank’s appraisal and your committed purchase price. Not a fun prospect for most people.
In our next post we’ll discuss questions that you should be asking around the monthly cost but before you get to those, start by focussing squarely on the price you will pay when you’re ready to buy the home and ask for justification. That single question could save you thousands of dollars and help you to avoid a potential pitfall.