Rent to Own Hazards for the Seller
As shown on the risks for the buyers, these arrangements are generally transactions of desperation for the buyer. This is likely true for the seller as well. In most circumstances, it is better for a traditional seller to engage in a cash transaction with the buyer. The advantages of that are obvious: immediate payment, no future risk of depreciation, no on-going management requirements.
However, there may be times that the seller simply must get someone in the home or must sell the item. If the banks are not lending and the buyer is not able to obtain the necessary credit to buy the house, the seller may be willing to engage in this kind of transaction. If a seller is going to sell using a rent to own transaction, the following risks should be considered:
Know the Law in Your State
Know the law in your state: There are potentially serious consequences for engaging in one of these arrangements without fulling understanding the law governing them. Many states create huge financial penalties against the seller for failing to comply with these consumer protection statutes. Also, if you engage in a rent to own transaction for a vehicle, you may be subject to a lawsuit if the buyer is not a competent driver, just like a car rental company could.
Know the Valuation Risk
Valuation risk: With these transactions, the seller still holds two significant risks related to the value of the property. First, if the value of the property falls significantly during the term of the rent to own, the buyer is generally free to walk from the transaction. This can happen with homes, cars, computers, TVs, almost anything. Thus, the seller has sold the property but retained the potential of depreciation loss. Second, if the value of the property climbs significantly, the seller no longer owns the right to recover the benefits of the appreciation. Instead, now the buyer has the right to exercise the right to purchase and the seller would be in breach of the agreement by refusing to sell.
Understand the Impact of Mortgages or Debt
Watch the mortgage: The seller, unless they own the property outright, must review the language of any debt contract with the lending entity. It is entirely possible that the contract between the lender and the owner includes an acceleration clause that would make the entire remaining amount of the loan due upon the execution of the rent to own contract. This can happen with a car or a home, or anything else where the seller has a debt contract on the property being sold.
Who is responsible for maintenance?
Maintenance: Even if the contract assigns maintenance responsibilities to the buyer, until the termination of the contract, there will remain a chance that the seller will have to repossess. In that event, the costs of depreciation caused by property neglect would fall on the shoulders of the seller. So, one of the advantages of this approach over renting is illusory because the seller would still be interested in verifying that proper maintenance was performed on the property. Consider for example if the item sold is a computer. The value of the computer is significantly less if it no longer works. So, the seller needs to know that there is a significant maintenance risk involved with any of these transactions.
Understand What Happens with the Interest Rates
Fixed v. Variable interest rates: Generally, when these types of transactions are considered, the payments are expressed in real terms (dollars per month) and not in terms of principal payments and interest payments. This can lead to a particularly nasty consequence if the seller’s mortgage is a variable rate loan while the rent-to-own contract is expressed as a fixed payment. In that event, the seller could end up unable to meet the property’s mortgage obligations if interest rates were to rise beyond the monthly payment received from the buyer.
These are some of the risks to the seller in these transactions. While a seller may be in a position to execute a rent to own contract, the seller should not do so without fully understanding the myriad of risks involved.