Rent-to-Own vs. Seller Financing

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When looking for home financing, it's easy to confuse a rent to own transaction with seller financing. These two approaches may sound similar, but there are some important differences.

Rent to Own vs. Seller Financing

With most rent to own programs, the buyer/renter has the “option” to buy the home at some time in the future. Until that time, the owner/landlord is the real owner of the home. The owner/landlord’s name is on the deed, and that’s the person who is ultimately responsible for mortgage payments (if any) on the home. The renter has the right to purchase the home someday, but the renter is not obligated to buy. What's more, the deal can fall through, and the buyer/renter might not ever end up owning the home.

When owner financing is used, ownership of the property changes hands at the beginning; the buyer/renter becomes the new owner at closing. The buyer will pay the former owner (perhaps for several years) in a way that may look very similar to a rent to own transaction, but the buyer is paying off a loan after a purchase that has actually happened – not making rent payments (or other payments that might be applied towards a purchase that may or may not ever take place).

Similarities, Risks

Although rent to own is very different from seller financing, there are some similarities. In either case, the buyer might make payments to the seller until the buyer gets a loan from somewhere else (typically the buyer will apply for a loan with a bank or mortgage lender). During this time, the buyer is ideally working on building credit so that he can qualify for a loan. Again, the main difference has to do with when ownership is transferred.

The timing of a change in ownership is important because each party has different risks, depending on whether or not they own the property. For example, in a rent to own transaction, buyers take a risk that the owner/landlord will fail to make mortgage payments and lose the property through foreclosure – in that case, buyers would have been better off with seller financing (or buying the home with a traditional loan). Buyers also run the risk of the deal falling apart if they can't make monthly payments (especially if the owner is motivated to take advantage of the situation).

With the examples above, you might assume that it’s always better to be the owner of the home, but owners also take substantial risks. Sellers have a lot at stake when they offer owner financing: if the buyer doesn’t pay (or can’t get a loan), the seller may need to foreclose on the home. That means paying legal fees and evicting the buyer, not to mention finding another buyer.

With either type of program, there are numerous complications and things that can go wrong, which should not be surprising given that you have two (or more) parties with interest in a property. If you’re considering either of these approaches, be sure to learn about the risks by speaking with a local real estate attorney. It’s hard to imagine all of the pitfalls, but there are too many of them to ignore, and a professional can help you figure out if it’s worth the risk.