Is the purchase price important?

It seems obvious to say that, when making a purchase of any sort, you'd like to get a good price but certainly you wouldn't want to pay more than fair market value.  You shop around, do a little research, and make your purchase.  Sometimes convenience and/or availability trumps price, but that's the decision you make.

When we get to big ticket items like real estate, at the moment you are trying to arrange financing, the mortgage lender will seek and rely on an "appraisal" to confirm or determine Fair Market Value ("FMV") because a lender will only agree to finance to the lesser of appraised or the agreed to purchase price.

If a property you are buying right now doesn't appraise, you renegotiate the purchase price, come up with more down payment, or you cancel the deal.

However, if you are entering into a lease with an option to purchase (rent-to-own) transaction, things get a bit tricky as you are essentialy agreeing today on what the purchase price will be at the end of your lease, say two years from today.  When it comes time to get your mortgage, your bet/hope is that the agreed to purchase price is less than (or at least no greater) than the Fair Market Value as determined by an appraiser.  If the FMV is less than the purchase price, you will need to come up with the difference plus your down payment to get your financing approved.  Let's look at a couple of examples.

In the first case, let's say you agree to a lease-purchase transaction that gives you have the option to buy a property at $249,900 at the end of your two year lease. Now let's say when the time comes to get your mortgage the property appraises at $220,000.  If you were planning on financing 95% of the purchase price and the lender determines the FMV is $220,000, then 95% of that - or $209,000 - is the maximum loan available. So in order to complete the transaction, you are required to come up with the $40,900 difference less what ever down payment credits you have with the seller!  If you had accumulated, say, $15,000 in down payment credits between initial down payment and monthly rental premiums, then you are short almost $26,000! All the money you put towards the rent-to-own that was supposed to be a credit to your down payment is now lost!
In the second case, let's say you are offered the option to buy a property at $349,900 at the end of your two year lease.  But before signing the rent-to-own paperwork, you do a little bit of digging and discover that the FMV of the house today is actually only $300,000.  Next, you take an educated guess on how much the house is likely to appreciate in two years.  For example, if the value goes up 10%, then FMV in two years will be $330,000 and you'll have the problem in the first example.  So now, with a little knowledge, you negotiate the purchase price to a number that makes sense to you, or you walk away from the deal and save your down payment in the bank instead!

So the question from the outset was, is the purchase price really important? And the answer is - absolutely! You are negotiating a real estate transaction price for gosh sake! If you don’t know what you are doing, chances are you will loose. If you end up with an option to buy something at $250K that you could just buy on the street at $220K, then, unless you have more than $30K in down payment credits (the difference), your best next step might just be walk away - hopefully a little wiser. Don't go there.

Worth repeating, rent-to-own is a stepping stone to home ownership, not a substitute. You must be able to get a mortgage within an agreed to time frame - that’s your bet. Contact me for help.

Topics: Rent-to-Own, Buying a home, Negotiating