There is a big difference between Lease Option and Owner Carry or Owner Financing.
When you lease option a property, you are still a tenant but have the right to buy the property at a future date. You give the landlord/seller a deposit that they agree to credit you for, in addition to a portion or your rent each month, that will be used towards your down payment and/or closing costs when you exercise your option to purchase. Depending on how the agreement is written, you may also be responsible for any maintenance, upkeep and repairs on the property while you live there (remember, you do plan on owning it one day).
For example, you and the seller agree that you will buy his house for $100,000. But since you can’t get a loan right now, you will give him $5,000 as an option deposit, and out of the $1000 a month rent you pay, he will credit you $250 each month your rent is on time. So at the end of one year or 12 months, you’ll have $5000 + (12 X $250 or $3000), which totals $8,000 towards purchasing the house. If you’re able to purchase the house in 12 months with an FHA loan, 3 1/2% or $3,500 would be counted as your down payment and the rest of your credit of $4,500 would be used towards your closing costs.
The good news is you now have enough money to be used to purchase, had 12 months to fix whatever your credit problem may have been so you can qualify for a mortgage, and you probably won’t have any additional money to come up with in order to get a loan. You didn’t have to come up with 10-20% as a down payment. Also, you don’t have to buy the house if you don’t want to but the seller can not sell to anyone else until you decide whether or not to exercise your option. Of course, you have to pay your rent on time or you can void the contract.
The bad news is you are still a tenant and don’t get any tax benefits from paying for the house. Also, depending on how your agreement is written, you may also be responsible for doing all the repairs on a house you don’t own. And most important, your deposit and any rent credit you may be earning is not refundable to you if you choose not to exercise your option to buy the house.
Owner financing is completely different. When you purchase a property where the seller/owner agrees to act as the bank, you will actually go through escrow. Your deposit is now a down payment, and your payments will be treated the same way as if the bank was financing with you. However, several things are important to know:
1. You will have escrow fees and inspection, and closing costs. Here in Las Vegas that is anywhere from 1-4% depending on the price of the house (the cheaper the house, the higher the percentage because some costs are fixed no matter what the price of the house is).
2. Your down payment will usually be as little as 10% to as much as 50% of the price of the house, depending on what you and the seller agree to.
3. You will usually pay retail or slightly above retail price for the house. Seller’s offer financing because they don’t want to sell for the same price the bank owned or short saled house down the street is going for.
4. Sellers offer financing because they can get better interest from you than they can from the bank, so expect to pay 1-5% more for your mortgage. Right now banks are financing loans for under 4%. Most sellers are offering to finance you for 5-10%. Its their house and they can ask whatever they want in interest.
5. The seller usually only agrees to act as the bank for 3-5 years, sometimes 10 years, but seldom longer. They don’t want to be the bank forever. So whatever is preventing you from getting a loan now, you have to use this time to fix your credit, stabilize your income, and possibly work with a loan officer so you’ll be able to get a mortgage in a few years.
6. You now become the owner of record and you get the tax write off for the property.
Owning is always better than dealing with a landlord, but either one of these paths will help you become a homeowner.