There are literally dozens of ways to purchase property. Some you have heard of others, probably not. What is important is the fact that there are many more benefits to owning rather than renting. Below are the four most common types of purchase methods used today.
Keep in mind that nowadays no matter how you plan on buying (even rent with option) you must have some type of down payment, credit scores of 625 or higher and steady income.
Conventional ‘Standard’ Sale
A ‘straight forward’ purchase where the buyer obtains a loan and the property is transferred at a ‘closing’. This is the most common transfer of property. Usually this includes a mortgage debt to a lender but, sometimes may involve ‘cash’.
Rent with Option
A Buyer fronts (puts down) money (usually 2%-4% of the price) for the ‘option’ to purchase the property in the near future (usually 1-3 years). The Buyer essentially ‘rents’ until that time. The Buyer has the option of purchasing at the end, or anytime during the term of lease. If the buyer does not execute his option the seller retains the front money. The purchase price is usually agreed upon in the beginning but, sometimes settled by an appraisal near the end of the term.
Buyer fronts money (usually 2%-4% of the price) for the purchase the property in the near future (usually 1-3 years) and essentially rents until that time for a higher than market rental rate with the difference (say 20% of each monthly payment) being applied to the purchase price. This builds some equity in the property. The Buyer must perform at the end of the term or, is essentially in default. The purchase price is agreed upon in the beginning.
Contract For Deed (Articles of Agreement)
In what is essentially temporary owner financing, a Contract for Deed sale gives a buyer the opportunity to purchase a property if they ‘just miss’ qualifying for a conventional sale with traditional financing. When a buyer hasn’t yet sold their existing home or needs a little credit repair, a Contract for Deed allows them to purchase with short term owner financing now, and refinance with a traditional lender later.
Contract for Deed works similar to purchasing a car. The buyer gives a down payment on short term financing. The seller acts like the bank – just like Ford or Toyota would but for a shorter time period. The buyer gets use of the car and is responsible for maintaining the car. After the buyer pays off the note on the car (ie. refinances) the seller gives up the title to the car.
With no lender or bank involved, a Contract for Deed gives the buyer and seller more flexibility when negotiating the interest rate, the size of the down payment, and the terms of the loan. The buyer does not have to provide tax forms, pay for an appraisal, or wait weeks for underwriters so move in can happen quickly. There are also very little closing costs right now.
Contract for Deed is initiated using a regular real estate sales contract along with an addendum that spells out the rough financial terms. As with other real estate contracts, the buyer puts down earnest money and arranges an inspection. Most importantly, there is still an attorney review period while the contract and addendum are approved and finance terms are formalized.
After executing a Contract for Deed, the buyer takes possession of the property and per the signed mortgage makes monthly payments to the seller much like a conventional mortgage (ie. PITI plus any assessment). Since the Buyer has an Equitable Title the buyer can make improvements like paint, carpet, even small renovations. Any equity gain after the first closing is the buyer’s gain. Note: this is not a rental, there is no landlord. The buyer is responsible for all maintenance.
In the near future (usually 6-12 months) the buyer refinances with a traditional lender or bank and pays off the Seller. That’s the second closing. At this closing the seller provides the buyer with the survey, the title, the tax escrows, etc just like a traditional closing. There is no ‘prepayment penalty’ on the contract mortgage. The buyer can refinance out of the contract mortgage and over to their favorite lender at any time.
Contract sales can vary but often retain some core elements. The buyer pays the seller monthly payment of Principle and Interest, as well as 1/12 of the seller’s current Taxes and Homeowner’s Insurance. No mortgage insurance is required. Most often contract mortgage paperwork states a buyer cannot make significant property changes (i.e. an addition or work requiring a city permit) without the seller’s approval and must use professionally licensed/bonded contractors.
Buyer Benefits: A Contract for Deed gives buyers who can’t quite qualify for a mortgage a way to buy. Another advantage is that if a buyer falls behind in payments, the seller can’t demand payment in full (like a mortgage lender). The buyer only needs to make up the missing payments and late fees to restore the loan. There is no loan application fee for the buyer, no mortgage insurance premium either.
Seller Benefits: The Contract for Deed is a simpler, quicker sale process than waiting for a lender. The seller often receives an interest rate higher than a savings account and is backed by a mortgaged security. Unlike Rent With Option or Lease Purchase the buyer is responsible for all the maintenance. The seller retains title of the property until the terms of the contract sale are completed. If the buyer defaults and fails to make missed payments, the seller can reclaim the property and any improvements the buyer made.
Note about brokers: Real Estate broker commissions are due when the property is sold (first closing). However, when the down payment is less than 10% the brokers often agree to ‘delay’ compensation until the buyer refinances.
Owner financing is a great way for a buyer to get the home they want without having to first sell and close on an existing home or without qualifying for two loans. They get the property they want and never risk being homeless. The seller benefits as well because, unlike Rent With Option or Lease Purchase, they no longer have responsibility for the maintenance and repairs.
In every scenario above a buyer will need to have decent credit and have steady reliable income.