Would you call this a good deal?

[shedinator]

I contacted a potential landlord yesterday about a home that's in our rental price range, and got the following response:

"The property is actually rent-to-own. The price is $X,000. With a 20% down payment, it's 1.6%/month for 50 months. For 12% down, it's 2%/month for 44 months. If you want to pay cash up front, we'll sell it for 80% of purchase price."

I have the 12% that I could put as a down payment, and we were planning to pay 2% of the purchase price in rent anyway. However, I can't decide whether this is a good deal. If you look at it one way, it's a short-term, 0% mortgage on 100% of the purchase price of the home. But if they're willing to sell the place for 80%, that could be seen as the "real price" and the total price we'd pay over 44 months would be 125% of real price. That's more like 12.2% interest (paid in a lump sum up front), which would be about the same as purchasing the home on a low-interest credit card.

At the same time, the alternative is paying the same amount to build 0% equity in a home where we'll probably live at least 2-3 years, in exchange for being covered if the water heater conks out or the pipes freeze. Even if we viewed it as a 12.2% loan, that's at least 50% of real price in equity, which is a pretty steep rate for an insurance policy.

As you can tell, I'm of two minds about whether this is a good offer or a bad one. What do you think?

[sol]

I think it totally depends on real estate prices and rents in your market, and not on the interest rates being offered by the seller.

[shedinator]

I think it totally depends on real estate prices and rents in your market, and not on the interest rates being offered by the seller.

Zestimate says even the more expensive option is below market rate. Other sites that offer comparables say more or less the same thing, although they differ on how far below market rate. I've seen quite a few pictures, and have a mental inventory of minor repairs that need to happen, plus whatever an inspector would pick up on. Even with the things on my list factored in, total cost would come in below comparable homes in the area, so long as the inspector didn't find anything major.

[velocistar237]

It depends on all factors together in the buy vs. rent comparison. Any incomplete set of factors will not tell you the whole story. Sit down and do the full comparison. Only then should you have any confidence to make a decision.

[Mr Mark]

It's a strange 'rent to own' proposition. First off, make sure you have your own property lawyer OK anything before you sign (or even verbally agree). Issues are: From when do you own the house? Who's responsible for insurance, property taxes and repairs in the interim? What if the seller goes broke or is foreclosed upon? Are there other fees? What if you miss any payments? Can you pull out of the deal later? Can the seller sell to someone else? Can you?

Of the two options, the better deal financially (by a whisker) is the 20% down & 1.6% a month, but assuming a discount rate of 7%, the delta between the two options [12% vs 20% down] is only a negligible 0.22% of the total.

BUT, as you worked out, the 12% deposit rent-to-buy deal is effectively the same as a 4 year mortgage, with 20% down, at a 14.1% p.a. interest rate [this analysis ignors any fees and closing costs].  So if you can, you'd be a lot better off getting a normal mortgage (if you can for what is probably a small amount?). A 4 yr mortgage @4% p.a. with 20% down would give you monthly payments 28% less the 12% deal. Overall, the ordinary mortgage deal paid off over 4 years is way better. You'd save ~13% off the rent-to-own purchase price with a mortgage.

The difference between renting (for ever, earning 0 equity) and this purchase depends on property taxes, & the fact you'll be locked in for 4-5 years.

[velocistar237]

Is this the same as an "owner carry"?

[shedinator]

Is this the same as an "owner carry"?

generally, yes. The "standard" approach to rent-to own is usually that while you're renting, the landlord holds the deed, and turns it over when you've paid it off. Payments are usually a little higher than average, and can look like 10-12% interest or more, but they tend to include taxes and insurance, whereas payments on a home do not. More often than not, the period on a rent-to-own is shorter than the standard 30 years. There are some downsides to the process which aren't present in a regular mortgage, though. If the owner is holding the deed, s/he isn't necessarily required to grant you equity prior to the transfer of deed, so you could put a few years in, find yourself having to move, and leave with nothing. Also, the contract on rent-to-own often emphasizes the "rent" part. Ie, the owner/seller can evict you for missed payments, whereas a bank has to go through the foreclosure process, and will usually give you time to sell the home and recover some of your equity. I'm personally wary of the concept of rent-to-own, as the terms do a lot to protect the seller's rights, and not much to benefit the buyer. The industry is also packed with predatory lending (think of rent-a-center, but for houses), where people end up paying several times what they would have if they'd bought the house outright using a standard mortgage.

I think we're just going to see if there are other homes in the area going for the price range that would make them truly cheaper to own than we planned on paying in rent. If there are, we'll buy one the traditional way. If not, the rent-to-own probably sounds too good to be true for a reason :).

[Mr Mark]

From what you've posted, it looks like a great area for landlords (and for you to purchase) , if the market rent is that high compared to the house prices! Paying off a mortgage in 5 yrs at a rate that is same as renting seems like a deal. Maybe the area was hit hard by foreclosures?

[arebelspy]

Better option than the ones they gave you:
Get a traditional fixed mortgage and buy it from them.

They're offering 80% of the asking price if they get cash.  Meaning you should be able to negotiate and get it cheaper (say 70% of the higher price, another 5-10% off at least).

Then go get a mortgage for that cheaper amount.  That 12% down is suddenly 20% down on a lower purchase price.