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What Is a Lease-to-Own Home and Is It a Good Option?

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

You’ve heard of a car lease, but what about a lease-to-own home? In this scenario, a tenant agrees to a lease with an option to purchase the property down the road, typically no more than three years from signing the agreement. Set forth within that document are the rental payment amount, accrual toward down payment and the home’s sale price. But does this make sense for your personal financial situation?Many who enter into these agreements do so because issues such as lack of a down payment or credit problems may block them from a traditional purchase. In a nutshell, they are able to use the rent they will pay before purchasing as their down payment.

However, there are a few risks to consider up front: Primarily, the lease-to-own industry has been pockmarked with less-than-ethical dealings, and consumer protections have been slow to emerge in response. That said, it can simplify the ownership process for people who wish to buy but find themselves in a tough financial spot.

Renting to own is not a terribly common choice. In fact, according to the 2016 Profile of Home Buyers and Sellers produced by the National Association of Realtors, just 1% of those purchasing a home in 2015 were renting to own.

Lease-to-own homes: What’s the process?

You’ll choose between two types of rent-to-own arrangements:

  • A lease-option agreement, which requires a nonrefundable deposit at the beginning of the lease term as part of the purchase price — money that will be kept, should the tenant decide not to buy the property
  • A lease-purchase agreement, which does not require that any money be paid upfront, but is more concrete in what it sets forth, including when the purchase price will be decided and a date when the sale will take place

Throughout the life of the lease, you’ll be paying rent as you would with any standard tenant agreement. However, the meat of that agreement is different than with your typical landlord-tenant contract, as it spells out terms under which you as the tenant will eventually purchase the property.

Sounds great in theory, but how does it work in reality? If you have a lease-option contract, you’re on the hook to find financing to pay off the balance of the purchase price — and if you can’t, you’re out any money paid up until that point. This gets dire if your contract is lease-purchase, as you could be sued if you can’t or won’t buy the property as agreed.

“You might be told it’s a chance to ‘stop throwing money away on rent,’” Federal Trade Commission consumer education specialist Amy Hebert wrote in an online brief. “But we’ve heard that many people who thought these deals were a path to owning a home watched their dreams disappear instead.”

Understanding lease-to-own contracts

When you sign a lease-to-own contract, it will include:

  • The lease or rental agreement, which stipulates that the landlord will retain the title to the home until the tenant exercises the option to the property. Like a typical rental agreement, it also includes terms like the amount of monthly rent, the lease period and the division of maintenance and repair responsibilities between landlord and tenant.
  • The option provisions, which include purchase price, the amount of time the tenant has to complete the transaction, the option fee, which is typically 1% of the purchase price and rent credit, a 10% to 15% premium above market rent that is collected by the seller and rolled into the down payment when the purchase goes through.
  • The purchase provision, which must denote the option fee, the purchase price and the duration of the option period.

What to do before signing a lease-to-own contract

Before signing on the dotted line, you need to take the following steps:

  • Have an attorney review the agreement — local knowledge is key, as different states have differing laws about rent-to-own contracts — and have him or her rework it to be as favorable to you as possible.
  • After your attorney gives his or her approval, get in touch with a lender. Make sure the lender also reviews the contract, and ask to be prequalified; both steps will give you more reassurance that you will be able to handle the purchase down the road.
  • Get a qualified appraisal and inspection before signing anything so that you know exactly what you’re dealing with upfront.
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Pros and cons of lease-to-own home programs

Benefits of these programs include:

  • Buying without having to qualify for a traditional mortgage
  • Building equity in your home before the actual purchase
  • Locking in current prices in an escalating market
  • Testing the neighborhood out before committing to it
  • Saving the hassle of a move later on
  • Being made to save a down payment through rent credits

However, there are drawbacks.

If you fail to qualify for a loan at the end of the lease, be prepared to lose money that you’ve invested through an option fee, rent credits and rent itself, making the property a rental for which you’ve paid above market rate for no return.

Some contracts specify that you are legally obligated to purchase the home at the end of the lease, so if you’re not careful, you can get yourself into legal issues with a contract that you aren’t able to honor.

The dark side of lease-to-own programs

The lease-to-own industry has had its share of controversy. In her online brief, Hebert writes: “In a rent-to-own deal, the person or company that owns a home agrees to sell it to you in the future for a specific price. Rent you pay now is counted toward your future down payment on the house. But these deals can be risky — and even flat-out scams.”

Such scams, as outlined by Hebert, include finding out the following.

  • The property owner has failed to pay taxes on the home
  • The seller does not truly own the property
  • The house is a foreclosure
  • The home is in poor shape or has major issues like asbestos or lead
  • Promised repairs are not made after the signing of a contract

Moreover, a National Consumer Law Center report finds that land contracts, which proved popular with investors because borrowers who defaulted were without traditional mortgage protection and could be rapidly evicted — preyed largely on African-American, Latino and immigrant populations. These contracts, which placed the responsibility of upkeep on the renter (and would-be owner), were also deemed as “a transaction built to fail.”

The lesson: Buyer beware. Watch out for scams.

Conclusion

While rent-to-own contracts may seem appealing as an alternative to traditional home purchases, those looking to sign such an agreement should proceed with caution. This may be a worthwhile option for consumers who have a clear path to homeownership but a few temporary barriers to getting started. But it also can be risky, controversial and downright dangerous for the wrong people in the wrong situation.

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Here are the Best Low- or No-Down-Payment Mortgages

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

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It’s an often-cited rule of thumb, but you don’t actually need a 20% down payment to get a mortgage. In fact, you can get a home loan with little money down, and even a no-down-payment mortgage.

Assuming you’re financially prepared for all of the other responsibilities of homeownership, consider the following mortgage programs.

No-down-payment mortgage options

USDA loans

The U.S. Department of Agriculture (USDA) insures home loans made by approved lenders to eligible homebuyers in designated rural areas. As the program states, USDA loans were created to improve the quality of life in rural areas by giving families the opportunity to own a “modest, decent, safe and sanitary” home as their primary residence.

There’s no required minimum down payment or mortgage insurance, but there are guarantee fees. A portion of the fee is paid upfront and is 1% of the loan amount; the other portion is 0.35% of the loan amount and is paid annually.

To be eligible, you must:

  • Have a low-to-moderate income for your area
  • Buy a home in a designated rural area
  • Have a preferred minimum 640 credit score
  • Have a maximum 41% debt-to-income (DTI) ratio

VA loans

The U.S. Department of Veterans Affairs (VA) also offers a no-down-payment mortgage option guaranteed through its VA loan program. These loans cater to active-duty military service members, veterans and eligible spouses, and are offered by private lenders.

Borrowers aren’t required to make a down payment, but there is an upfront funding fee — which ranges from 1.4% to 3.6% of the loan amount — to help offset the program’s costs to taxpayers. The loan must be used to purchase a primary residence.

To be eligible, you must:

  • Have a certificate of eligibility from the VA
  • Have a preferred minimum 620 credit score
  • Show proof of stable income
  • Have a maximum 41% DTI ratio

Low-down-payment mortgage options

Fannie Mae HomeReady® and Standard 97% LTV

Fannie Mae has two low down payment conventional loans: HomeReady® and Standard 97% LTV. The HomeReady® mortgage program is open to both first-time and repeat homebuyers, while the Standard option requires at least one borrower to be a first-time buyer.

Borrowers can’t earn more than 80% of their area median income (AMI) if applying for a HomeReady loan. Additionally, if all borrowers on either a HomeReady or Standard loan are first-timers, at least one of them must complete an online homebuyer education course.

Both programs also require private mortgage insurance (PMI) if you make a down payment of less than 20%, though PMI can be removed after you reach 20% equity.

To be eligible, you must:

  • Have a 620 credit score
  • Have a 3% minimum down payment
  • Have a maximum 50% DTI ratio

Freddie Mac HomeOne and Home Possible

Freddie Mac’s HomeOne mortgage is reserved for first-time homebuyers and doesn’t include any income restrictions. The Home Possible® loan is an option for first-time and repeat buyers with a low to moderate income.

Your income must not exceed 80% of the AMI for a Home Possible® loan. You may qualify without a credit score, but your minimum down payment rises from 3% to 5%. Cancellable PMI is required for borrowers who put down less than 20%.

There’s a homebuyer education requirement for both HomeOne and Home Possible® programs when all borrowers on the loan are first-timers.

To be eligible, you must:

  • Have a 3% minimum down payment
  • Have a minimum 660 credit score
  • Have a maximum 50% DTI ratio

FHA loans

The Federal Housing Administration’s (FHA) low down payment home loans require just a 3.5% contribution and a 580 credit score. You can also qualify for an FHA loan with a credit score of 500 to 579 if you have at least a 10% down payment. Other FHA loans, such as construction-to-permanent loans and 203(k) loans, have the same credit score and down payment requirements.

FHA loans require upfront and annual mortgage insurance premiums (MIP). The upfront premium is 1.75% of the loan amount; the annual premium ranges from 0.45% to 1.05%, is divided by 12 and paid in monthly installments as an addition to your mortgage payment. Borrowers who put down at least 10% only pay mortgage insurance for 11 years; putting down less means you’ll pay MIP for the life of your loan.

To be eligible, you must:

  • Have a 580 credit score and 3.5% down payment
  • Have a 500 to 579 credit score and 10% down payment
  • Borrow within your county’s FHA loan limits
  • Have a maximum 43% DTI ratio

Good Neighbor Next Door

The Good Neighbor Next Door program from the U.S. Department of Housing and Urban Development (HUD) allows homebuyers in certain public service professions to buy a home at a 50% discount. If you qualify for and use an FHA loan to buy a home, the down payment is only $100, instead of the minimum 3.5% that’s usually required.

Eligible borrowers must buy a home located in a HUD revitalization area and commit to live in the home for at least three years. They must also sign a silent second mortgage for the discounted amount, though no payments are required if all program requirements are met.

To be eligible, you must:

  • Be a full-time pre-K through 12th grade educator, emergency medical technician, firefighter or law enforcement officer
  • Buy a home in a HUD revitalization area
  • Qualify for a conventional, FHA or VA loan
  • Live in the home for at least three years

Pros and cons of no or low down payment

Pros

Cons

  • Buy a home sooner. It can take years to save up for a larger down payment. By contributing 0% down or the lowest possible amount, you can reach your homeownership goal in less time.

  • Avoid depleting your savings. If you limit how much money you contribute to your home purchase, you can leave some of your emergency savings intact. Lenders want to know that you can weather financial hiccups, such as a job loss or income reduction.

  • Start out with less equity. The less money you put down, the less home equity you’ll have initially. This means your ownership stake in your home is much smaller, which may lead to pocketing less money if you need to sell in a few years.

  • Take out a larger mortgage. A no- or low-down-payment mortgage means you’ll be close to financing 100% of your home’s purchase price. A larger mortgage means a higher monthly payment amount.

  • Pay more in interest over time. The more money you borrow, the higher your interest rate typically will be. This also means you’ll pay more in interest over the life of your loan.

FAQs about mortgage down payments

Yes, there will be closing costs to pay on your home loan. Mortgage closing costs can range from 2% to 6% of your loan amount. You can pay these costs out of pocket at the closing table, or ask your lender about a no-closing-cost mortgage. With this type of loan, your lender will either increase your mortgage rate or add the closing costs to your loan amount, instead of having you pay those costs upfront.

It depends on the type of mortgage. Conventional loans require private mortgage insurance when you put down less than 20%, and it can be canceled after you’ve built at least 20% equity in your home. All FHA loans require mortgage insurance premiums, but if you put down 10% or more, you can get rid of MIP after 11 years.

Reach out to your loan officer and real estate agent for help identifying any down payment assistance programs you might qualify for. You should also check with your state’s housing finance agency.

Many loan programs let you use monetary gifts from family members, friends and others to help cover your down payment, but there must be a specific paper trail for the gift. The donor will need to submit a gift letter to show that you won’t have to repay the money being gifted to you. Consult your lender for specific guidelines.

Yes, your down payment amount can affect your mortgage rate. The less money you put down, the riskier you can appear to lenders, and they can account for this risk by raising your mortgage rate.

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By clicking “See Rates”, you will be directed to LendingTree. Based on your creditworthiness, you may be matched with up to five different lenders in our partner network.

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5 Home Loans for People With Bad Credit

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.

You don’t need a perfect credit score to get a mortgage — there are home loans for people with bad credit. But before getting this type of mortgage, find out how a lower credit score affects your overall borrowing costs.

Buying a home with bad credit

It’s possible to buy a home with bad credit — you could have a credit score as low as 500 and still qualify for a mortgage. The lower your credit score, though, the fewer lending options you’ll have and the higher your mortgage rate will be.

FICO scores, the credit scores used by most lenders, typically range from 300 to 850. Having a lower credit score translates to higher risk for a lender, and vice versa. Any score 669 or lower is considered “fair” or “poor.” Here’s a breakdown:

  • Exceptional: 800 and higher 
  • Very Good: 740-799
  • Good: 670-739
  • Fair: 580-669
  • Poor: 580 and lower 

Lenders like to see high credit scores because it exhibits an ability to manage debt, make on-time payments and use credit responsibly. Your creditworthiness will come into question if you plan on buying a home with bad credit, but it doesn’t have to hold you back from homeownership.

5 home loans for bad credit

Consider one of the following home loans for bad credit.

Fannie Mae HomeReady

Fannie Mae’s HomeReady mortgage program is an option for both first-time homebuyers and repeat buyers with limited access to down payment funds and a fair credit score. This conventional home loan has cancellable mortgage insurance for those who put down less than 20%, and gives borrowers the option to use boarder or rental income to help them qualify. If all borrowers on a loan are first-timers, at least one borrower is required to complete a homeownership education course.

Eligibility requirements include:

  • A minimum 620 credit score
  • A minimum 3% down payment
  • A low- to moderate income

FHA Loans

Mortgages backed by the Federal Housing Administration (FHA) could be considered bad credit home loans because they make it easier for low-credit-score homebuyers to get a mortgage. FHA loans have a low down payment requirement, but you’ll pay mortgage insurance premiums (both upfront and annual) for the life of your loan. If you put down at least 10%, you can get rid of mortgage insurance after 11 years.

Eligibility requirements include:

  • A minimum 10% down payment for a 500-579 credit score
  • A minimum 3.5% down for a 580+ credit score
  • Borrowing within your county’s FHA loan limits

USDA loans

The U.S. Department of Agriculture (USDA) insures mortgages funded by approved lenders through the USDA home loan program. There’s no minimum required credit score, but a 640 score could help you get approved automatically if you meet employment and income requirements.

Eligibility requirements include:

  • No minimum required down payment
  • Meeting local income limits
  • Buying a home in a designated rural area

VA Loans

The Department of Veterans Affairs (VA) also offers bad credit home loans through approved lenders for active-duty service members, veterans and eligible spouses. The VA doesn’t have a specific credit score requirement, but lenders may require a minimum 620 score. No down payment is required. Additionally, most borrowers will have to pay an upfront funding fee to offset the cost of VA loans to taxpayers.

Eligibility requirements include:

Non-qualified mortgage loans

The loans discussed above are all qualified mortgages, meaning they meet certain requirements that establish a borrower’s ability to repay a loan. There are also non-qualified mortgage (non-QM) loans, which have more wiggle room for high-risk borrowers, such as accepting credit scores below 500.

Eligibility requirements include:

  • Demonstrating your ability to repay the loan
  • A minimum down payment up to 20%
  • A maximum debt-to-income ratio of up to 55%

How to get a home loan with bad credit

Use the following list of tips as a resource to help you get a bad credit home loan.

  • Avoid applying for new credit. A new auto loan, credit card or personal loan application means you’ll have new inquiries on your credit reports, which can drop your credit score.
  • Dispute any credit report errors. Finding and disputing inaccurate information on your credit reports could improve your credit score and help lenders see you as a less risky borrower.
  • Pay your bills on time. Your payment history makes up the biggest chunk of your credit score at 35%, according to FICO. Making on-time payments can help boost your score and demonstrate your creditworthiness as a borrower.
  • Lower your outstanding debt load. Pay down your credit card and loan balances. Lenders don’t want to see that your income is stretched too thin to afford a mortgage. Keep your credit usage below 30% of your maximum credit limit across each of your accounts.
  • Don’t close any accounts. Closing old accounts, especially credit cards, shortens your overall credit history and can negatively impact your credit score.
  • Have your rent payments reported to the credit bureaus. As long as you’ve been maintaining an on-time rental payment history, having your rent payments reported to the bureaus may boost your score.
  • Make a larger down payment. A larger down payment can compensate for a lower credit score. Don’t completely drain your cash reserves, though. Keep three to six months’ worth of living expenses in a savings account for emergencies.
  • Pay for mortgage points. If you have the extra cash, consider buying mortgage points to lower your interest rate and overall loan costs. One point is equal 1% of your loan amount and can lower your rate by up to 0.25%.

Should you get a bad credit home loan?

Home loans for bad credit come with more risk for lenders, so you can expect to pay more as a borrower. Crunch the numbers with a mortgage calculator to help you determine whether to move forward with a bad credit mortgage or wait until your credit profile improves.

Here’s an example of how your credit score can affect your costs on a 30-year, fixed-rate mortgage:

 620 credit score760 credit score
Mortgage rate4.84%3.25%
Loan amount$200,000$200,000
Monthly payment
(Principal and interest)
$1,054.17$870.41
Total interest cost$179,501.82$113,348.55

As you can see, improving your score from “fair” to “very good” could amount to a mortgage payment that is nearly $184 less each month, saving you more than $2,200 each year and more than $66,000 in interest over the term of your mortgage.

Advertiser Disclosure: The products that appear on this site may be from companies from which MagnifyMoney receives compensation. This compensation may impact how and where products appear on this site (including, for example, the order in which they appear). MagnifyMoney does not include all financial institutions or all products offered available in the marketplace.

By clicking “See Rates”, you will be directed to LendingTree. Based on your creditworthiness, you may be matched with up to five different lenders in our partner network.