An Example Rent To Own Scenario

Let’s take a more detailed look at a rent to own scenario to demonstrate just how valuable this tool can be.

Jacob wanted to buy a house, but he was afraid his bad credit and limited savings might be an issue. Jacob decided to look into his options, so he went to a lender to see if he could qualify for a loan.

The lender told Jacob that he could qualify even with his bad credit. Good news, right?

Not quite.

Because of Jacob’s bad credit, he would be required to pay the full 20% down on the home. For a $150,000 home this means Jacob would have to come up with $30,000! This seemed too far out of reach for Jacob. He usually had only about $200 leftover at the end of each month, and it would take him a very long time to come up with $30,000 at that rate!

Here are the loan terms that Jacob was pre-approved for:

Home Sale Price

$150,000

Loan Term

30 Years

Interest Rate (APR)

7.3%

Down Payment

20%

Monthly Payment Including Taxes

$971.44

Total Interest To Be Paid

$176,168.40

 

With taxes added in, the payment would have been over $150 more than the $800 that Jacob was paying for rent at the time.

Jacob knew that he had to do something different. The $30,000 down payment was well out of his reach since he had only $3,000 in savings, and the house payment would leave him with a measly $50 per month left in his budget, which wasn’t enough.

Jacob decided to take action and make some changes. He decided to use “rent to own” to make progress on buying a home while he worked to get his finances in order.

Jacob found a real estate agent who was willing to help him seek out a home that he could rent to own. They eventually found  a seller who was willing to enter into a rent-to-own agreement.

After working out the details of the deal, Jacob and the seller came up with a rent to own agreement that looked something like this:

  • The sale price of the house would be set at $135,000. Jacob aimed for less than he was pre-approved for originally so that he would be sure to get a loan that he could handle.
  • Jacob’s rent would be set at $800.
  • $300 of Jacob ‘s monthly rent would go against the final sale price of the house.
  • Jacob would rent the house for 3 years (the lease term) and have the option to buy the home at any time during that 3 years.
  • Jacob would pay an “option fee” to the seller of $3,500. This is a one-time non-refundable fee that Jacob would not get back. Jacob would also pay a $500 deposit which he would get back after the lease term.

Jacob had to work hard to come up with an extra $1,000 to cover the option fee and deposit. He worked some extra hours, and borrowed a little money from family and friends.

Once he had the money he went through with the agreement and the signing of the paperwork.

Then, Jacob went to work!

Jacob knew that his financial triad was holding him down. He knew he needed to improve his credit and his net worth, and that improving BOTH of those would be easier if he could improve his cash flow.

Jacob worked on his expenses and income, and between making some changes on his taxes and cutting back on some expenses, Jacob was able to come up with an additional $300 per month of “extra” income.

Next Jacob went to work on his savings.  Jacob took a number of steps and took on extra income generating work as part of his “down payment push” plan. Between his extra income from side jobs and the extra money he freed up in his cash flow, Jacob was able to put away $650 per month to go towards a down payment. Jacob also took on some seasonal work for a couple of summers which added another $4,000 to his down payment funds. Jacob

Jacob also went to work on his credit.  After Jacob freed up some cash flow and had some extra money coming in, he was able to put aside a small amount of money each month to work on improving his credit.

After about one and a half years, Jacob had saved $15,700 to go towards a down payment, and was making good progress towards improving his credit. He decided to relax a little and not work so hard, and from then on put away $150 per month towards his down payment fund.

10 months later, Jacob checked his credit and found his score had increased substantially. He contacted a lender to see what his loan might look like, and things looked good.

Jacob decided to exercise his option to buy the home he was renting, and went through the process to secure the financing for the home.

He had a total of $17,200 to go towards a down payment, and had $8400 in “option credits” which would be taken off the price of the home.

Since Jacob’s credit had improved substantially, he qualified for an FHA loan with a 3.5% down payment. Since he had more than that for the down payment, he used it, and this is what his final loan ended up looking like:

Home Sale Price

$126,600

Loan Term

30 Years

Interest Rate (APR)

5%

Down Payment

$17,200

Monthly Payment Including Taxes

$773.64

Total Interest To Be Paid

$123,807.00

 

Jacob’s house payment ended up a little less than what he paid for rent.  He got a better interest rate with his better credit, and came out much better on the loan, saving over $50,000 in interest.

Because Jacob already made several changes that improved his financial situation, he ended up much better off than he started out. He had more cash flow, better credit, and a home he could call his own.


You might be thinking at this point about the money Jacob put into the deal at the beginning. Remember that “option fee”? That probably hurt. You won’t necessarily always have an option fee in a rent to own agreement, but in a scenario like the one we’ve described here, it really doesn’t hurt or matter. Why not? Because, Jacob paid $3,500 to get into a rent to own agreement that ultimately saved him thousands. Over $8,000 of his rent money went towards the purchase price of his home, not to mention the money he saved on interest by not financing that $8,000.

He got into the home quickly, and got to live in the home he was buying while he worked on improving his credit and his finances.

That’s a great place to be. If you plan carefully and play your cards right, you might end up there too.

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