You find a rent to own home available, currently worth around $200,000. You sign an option agreement at the purchase of $200,000. 24 months go by and you are ready to close on the house.
Real estate prices have dropped and the home has just appraised at $180,000.
What Do You Do?
There are a few different options available to you as the tenant/buyer and they should be written out in the option agreement you signed upfront.
Tenant/Buyer Pays The Difference
There is a $20,000 difference between the option price and appraised amount.
After reducing $7,000 for a 3.5% option fee and $6,000 for 12 months of rent credits at $500 per month(during the first year only) you will need to pay $187,000 to purchase the home.
$200,000 Option price
-$7,000 Option fee(paid upfront)
-$6,000 Rent credits(12 months of on-time payments)
=$187,000 Remaining amount owed
If a lender will loan $180,000 on the home, then you have the OPTION of paying the $7,000 difference that the lender won’t cover. Keep in mind that you would still have closing costs.
Typically a tenant/buyer would not have the funds or would not be willing to pay so much money out-of-pocket to close on the home.
Extend Option Period
The following can and should be negotiated in the contract. If you qualify for a loan during the option period but the home is appraising for less than the agreed upon purchase price, you have the ability to extend the option period by a certain amount of time(usually 12-24 months).
Owner Reduces Price
Another possibility is the owner agrees to reduce the initial option amount to what the home is currently worth(appraisal amount).
But, don’t expect this to happen. This is NOT required of the seller so they would need to be highly motivated to sell the home to you and move on.
Seller Takes Home Back
This outcome is just as simple as it sounds. The seller can, and often times will, take the home back. In this case, you would lose all of the equity saved in the home.
If you are in a situation similar to this and the home appraises for less than the sales price then extending the option period would usually be your best outcome. Unless you no longer want the home. If that’s the case, then you have the option to move out out(depending on your agreements).
Keep This In Mind
Historically the housing market is going up each year. One of the MAJOR benefits of a rent to own is the possibility of building EQUITY without having the credit to qualify for a home loan.
For example if the $200,000 home you moved into is now worth $250,000. You still purchase the home at the original option price of $200,000.
So you have the $50,000 equity on top of your upfront option fee and rent credits!