Do Not Fall for Rent to Buy Mortgage Loan Schemes

(January 12th, 2008)

In current times of falling home prices in the US and the $1.8 trillion sub-prime mortgage debt that financial banks have to deal with, "Rent to Buy" signs are popping up everywhere to lure consumers into purchasing homes at "cheap mortgage rates." Rent to Buy is a marketing gimmick used by landlords to lease out their homes and receive rental income, only because they cannot sell their homes in the existing mortgage market. If you are renting, there is little benefit for you to fall for these schemes. The reason is because most Rent to Buy schemes do not result in a purchase. People with bad credit, no down payments and lots of credit card debt also qualify for rent to buy schemes. That's why you should avoid them.

New and existing home sales are expected to be 5.09 million in 2008, down 11% from the levels in 2007 (Source: Freddie Mac). There's an increased inventory of unsold homes in the US and home prices are stagnant or falling very fast. Real estate investors who are hoping to flip homes (a process of buying wrecked up old homes, do some home improvements and sell them at a higher price in the market) cannot sell them because wrecked homes are the hardest to sell in a market of falling prices and increasing inventory. So now, they are trying to rent them out.

Rent to buy contracts state that for every month's rent you pay, 1 portion of it will go towards the purchase price of the home, while the other will go towards "interest." They make it seem like this is a normal mortgage loan where a portion of your payment goes towards the original principal while the other goes towards interest. They make it seem like taking up a rent to own mortgage deal is worthwhile for you, and helps you build equity in to the home. That is rarely the case.

20 years ago, you wouldn't qualify for a mortgage without a substantial down payment, atleast 25%. Now because of the housing boom in the US in 2000 - 2005, lenders are hoping to make the big bucks by giving out loans to people with little or no down payments. With the current sub-prime mortgage debt, lenders have stopped doing this because they realize the risks of giving out loans to people with no savings or down payments, they will most likely default.

People who have recently declared bankruptcy, or people who have lots of credit card debt and no down payments are the number 1 target for rent to own schemes. Here are some pitfalls to avoid if you do ever sign up for a rent to buy mortgage loan:

i) Rent to Own schemes require you to pay an option deposit which is non-refundable. If you do purchase the home, that deposit is credited towards your down payment. However like we said, most rent to own mortgage schemes do not result in purchases, therefore if you do not make the purchase, you will lose that entire option deposit!

ii) Every month you pay rent, a portion of that amount is set aside to go towards the down payment. If your option to purchase the home comes up and you change your mind and do not want to purchase the home anymore, you will lose all the down payment you have made, as well as the option deposit you put down. That's why we say, stay away from rent to buy schemes!

iii) Thirdly, smart real estate investors will use your purchase option to justify you into paying higher rents, as well as lock you in for a purchase price that is higher than what comparable homes are selling for in the market. The real estate investor will act as if he is doing you a favor by letting you purchase the home in a rent to buy scheme. In return for this "favor", the investor will ask for higher rent, and a higher home price. Do not fall for this trap!!

iv) Fourthly, most people who take out rent to buy mortgages do not realize that they cannot afford to purchase their homes until the purchase option time arrives. You might find it comfortable to pay $800 a month in rent, but when it comes time to purchase the home, there are extra expenses you have to cater for. These include private mortgage insurance (PMI), property taxes and regular home insurance. Also, the maintenance that your landlord used to do when you were renting will become your responsibility after you purchase the home. Make sense??