Rent to Own … How much are the repayments?

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And, now for the third most popular rent-to-own question.

I’ve already written about the top two – 1.  Rent to Own, how does that work? and 2. How much is the deposit?

Finally, we’re tackling the number 3 question, “”How much are the repayments?”

Starting Point

I feel, the best way to understand how to arrive at a repayment figure is this …

Calculate the repayments a bank would charge!

That’s the going in number.

Now, how do you calculate what a bank would charge?

Easy.  Just go online and use one of the many mortgage calculators.  Or, ask your friendly mortgage broker.

What are the inputs?

I just use the basics.  Remember, we’re just looking for a starting repayment number.  We’ll modify as needed  later.

  • Loan amount:  Take the selling price and subtract the deposit.  Use the remaining balance as the loan amount.
  • Interest rate:  Use the going rate.  What is the lowest rate the bank will give someone without too much haggling.
  • Term:  Use 25 years.  Ok to use 30 years if you prefer.

Sample Calculation:

So, let’s say the home in question is selling for $320,000 and the deposit is $20,000 (I like easy numbers!).  And, the loan is principal and interest over 25 years.  The going interest rate is say 6.5%.

Using a friendly on-line mortgage calculator, I come up with repayments of $467 per week.

That’s a good starting point.

But, that’s way higher than rents in the area!

And, this is where you may meet the first objection from buyers.  If the bank loan repayments are much higher than the going rental prices, you’ll hear major objections.

But, let them object away!  You see, as a seller, you’re not looking for renters; your looking for buyers!

If this repayment number scares people away that’s probably a good thing.  You don’t want to put someone in your home who has a renter mentality; you want an owner … someone who thinks like an owner.

And, prospective owners will generally not balk at this going in repayment number because they’ve looked into getting a loan.  They know how much owners are paying.  They realize that owners may have to pay more than renters.

Why are repayments so high?

Well, the best way to answer this question is by asking, “why are the bank repayments so high?”

Want to be an owner, you gotta pay.  Want to be a renter, you may get to pay less.

But, after 20 years of rent payments, you still don’t own the home.  And, if home prices rise, a renter doesn’t participate in any capital growth.  But, the renter also doesn’t lose money if house prices drop.

And, it get higher!

If you think our repayment number is high, you’re in for a surprise because … it’s not.  It’s too low!

Why?

Well, first of all, when you take out a bank loan, who pays for insurance, taxes, maintenance, repairs, power and water?  The bank or you?

That’s right, home owners pay the outgoings!

In our calculated repayment above do you see any outgoings?

So, if you’re going to sell your home to someone are you going to pay for the outgoings?

The bank doesn’t, why should you?

So, What’s a Better Repayment Number?

I would suggest the final repayment number would contain the following:

1.  Start with our bank repayment amount:  $467 per week.

2.  Then add on outgoings:  $100 per week (assumption; could be more or less; base on tallying up outgoings)

3.  A rent credit amount.  I would suggest this would come out of the $467 per week above.  I’ll talk more about rent credits later.

So, via this method, the repayments should be on the order of $567 per week!

Another way to calculate repayments.

A second way to determine your repayments is as follows:

  • Start with the going rental price.
  • Then add on the outgoings.
  • Then add on a rent credit.

Let’s compute this number.

Market Rent:  $320 per week.  Let’s go with this number because it is a reasonable correlation between selling price ($320,000) and rent ($320 per week).  It’s fairly common to see rents running at about a 5% annual return on home price.

Outgoings:  Let’s go with our $100 per week estimate

Rent Credit:  Say, $100 per week.  This will come right off the price of the home.  Think of it as paying more of the deposit over time.

So, let’s add them up … $320 + $100 + $100 = $520 per week.

Now, that’s better.  A lot lower than what the bank wants.

Why you want to charge more!

You may think you’re doing your prospective rent-to-own buyer a favor by making the repayments lower.  But are you?

The whole idea behind a rent-to-own is to bridge the gap between renting and owning.  So, wouldn’t it be better for the rent-to-own buyer to demonstrate that they can make repayments that are on the same order as bank repayments?  Wouldn’t the bank be more comfortable giving a loan to someone who’s show they can make loan repayments and pay for outgoings?  After all that’s what the bank will expect you to do?

So, making the payments too low can hurt your rent-to-own buyer’s chances of getting a loan.  Why would you want to do that?  It’s almost as if you’re setting the buyer up for failure.

If you’re perspective buyer cannot make bank loan size repayments plus outgoings, maybe you should look for another buyer.

 Repayments – Be Flexible!

One of the aspects of rent-to-own is the flexibility.  Therefore, why not be flexible with the repayments.  Why not pick a repayment amount that works for you and the buyer?  Why not pick repayments that fit the particular situation at hand?

How can situations be different?

Well, what if you have a buyer who wants to put down a lot of money to have lower repayments?  Great!

What if you have a buyer who wants to put down less money and make higher repayments?  Great!

And, you need to verify buyer can handle repayments.  No use writing up a contract for repayments that puts the buyer in deep financial stress.  The banks wouldn’t do it, why should you?

Let me give you an example.  Let’s say you had a buyer who’s income is $1,600 per week.  This buyer is willing to make a $20,000 deposit, which is a very strong offer.

And, the buyer is willing to make the “bank loan size” repayments of $567 per week, with $100 as a rent credit.

Rent Credit?

Now, might be a good time to talk about the rent credit.  You can think of the rent credit as paying more of the deposit over time. Each week a portion of the rent is used to pay down the home price.  When you go to exercise the option to buy, the rent credits come right off the price of the home.

I calculate the rent credit by looking at my particular situation.  Let’s say I need $450 per week to cover my mortgage and outgoings, then I’ll place a rent credit on top.  For instance, if the buyer can handle and is willing to pay $550 per week, then I’ll offer a $100 rent credit.  If the buyer can only handle $500 per week, then I’ll reduce the rent credit to $50.  Let’s say another buyer is willing to pay $600 per week; I may up the rent credit to $150 per week.

It’s all based on the situation at hand.

Back to our example … Don’t want Repayments to exceed 1/3 income!

Even though your buyer is willing to pay $567 per week it’s a bit rich for this person.  Why?  Because the household income isn’t high enough.  You don’t want to see the repayment amount go higher than 1/3 of the household income.  Otherwise you introduce too much financial stress.  The banks don’t like it, you shouldn’t either.

In this case you could drop the repayment amount to 1/3 of the household income which would be $1,600 / 3 = ~$530 per week.

And, this number would fit well with our second way of calculating repayments above.  The number we came up with is $520 per week.  So, the $530 number might work well.

How about the Seller?

As the seller, you have to make sure this repayment amount works for you.  Will the $530 per week cover your loan repayments and outgoings?  If not, then you may want to look for another buyer.  If so, then go for it.  Sign them up and  get the deal in motion.

Unless … you get a better offer … go with the strongest prospective buyer.  The one that has the financial capacity and the “burn” to be a property owner!

Flexible and Tailored.

That’s a short introduction to setting up your rent-to-own repayments.  Hopefully, you can see that it’s all very flexible and can be tailored to each individual situation.  The only requirement is that both parties are happy with the deal and the buyer has the financial capacity – to carry it out.

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