Monday, November 29, 2010

Buying Real Estate Options with Bad Credit

Lately I have been approached a lot by people wanting to buy real estate, but can't because of bad credit, bankruptcy, recent foreclosure and so on.  So I thought I would post my thoughts on viable options to purchase a home in this real estate market.

The days of "rent to own" are gone.  Why you ask?  Well, let's think about it.  First, you agree to rent someone's home and pay them more than the rent each month.  The overage is supposed to be held by the owner and applied to your down payment.  Well the bank will view the overage as your down payment and will reduce the loan by the amount you have paid ahead.  For the sake of an example, let's say that your rent payment is $1,000 monthly with you paying an extra $200 to be applied towards the purchase.  Over a two year period, you would have paid $4,800 towards the purchase of the home.  You agreed to purchase the home for $150,000 at the conclusion of the two years.  So now you go to the mortgage company to secure your financing.  Instead of being financed for $150,000, you can only get financing for $145,200.  And on top of everything else, you also have to produce the required down payment of anywhere from 3.5% to 10%.  The better option is this case is just to lease the property for $1,000 monthly.  At the conclusion of the lease term, you obtain financing for $150,000 and only put down the required amount.

Some people think that lease-purchase agreements are the way to go.  These are viable and legal.  However, I don't advise people to do them right now because of the instability in the market.  For sake of example, you agree to purchase a home for $150,000 after a two-year lease period.  You begin the financing process.  The appraisal reveals the value to be $128,000.  Guess from where the difference of $22,000 has to come?  You!  The mortgage company is not going to finance more than the appraised value and the seller is not going to reduce the sales price just because.  There are protective clauses that can be included to protect the buyer, but any astute agent will advise the seller not to agree to them. 

A lease purchase agreement is one where the purchasee price of a property is agreed upon today with the actual sell of the property occurring at a later time.  Since the market is so volatile right now no one knows if the property will appreciate, depreciate or remain level.  If you have been following my posts, then you know that I believe we will experience more depreciation over the last two years.  For the buyer, this means they will have to come out of pocket in order to complete the transaction.  For the seller, this means that they will make a good deal of money in a down market, but most likely they find that they have lost a great deal of time during the lease period only to realize missed opportunities to have sold to other potential buyers.

Clearly, at this time I do not encourage anyone to go "rent-to-own" or lease purchase.  But don't fear there is still a viable option for those with struggling credit: FROR.  It is best for you to enter into a straight lease agreement and include a very important clause, "first right of refusal."  With this clause, the tenant/buyer is protected because the house cannot be sold from under them.  And for the seller, they enter the agreement knowing full well the time the house will be off the market.  It's a win-win for both.

Once the real estate market recovers, lease-purchase agreements will make sense again.  But for now, I advice against these two options.

Just as a footnote I want to give a bit of information about bankruptcy.  Chapter 7 is where the slate is wiped clean.  However, you are required to liquidate assets and creditors are paid off as much as possible from the proceeds.   Chapter 7 remains on your credit report for 10 years.  Chapter 13, on the other hand, is where a payment plan is established.  You are not required ti liquidate your assets and it remains on your report for 7 years.  With either, I have been told by several lenders that you will be able to obtain financing for a home anywhere between 2 and 4 years after filing.  Be aware that a higher down payment may be required as a result of the bankruptcy.

I included this information so there is an understanding of how long any lease should be in order to exercise the FROR option.   For more information, check out my website,

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