As a general rule, you are better off owning your home than renting one. However, there are specific situations where you may have to go for home rentals instead of home ownership. You can use a little known technique to determine if you can own a home for less down payment and lower monthly mortgage payment.
To illustrate this old technique, let us consider a hypothetical example. Let us assume that you are working for the purchase of a $250,000 home. If you are applying for a conventional loan of this scale, you will have to raise 20% as your equity, which is equivalent to $50,000.
In addition to your down payment, you will also have to shoulder survey, appraisal, origination fees and closing cost. The sum total of these cost items is equal to $5,000. If you are going to take out a $200,000 mortgage with an interest rate of 8%, a 30-year fixed-rate mortgage will give you a monthly mortgage of $1,467. If you account for taxes and insurance premiums, then your monthly mortgage payment can reach $1,800. On the other hand, your total cash outlay upon closing of the deal will be $55,000.
Let us also assume that your home property will not increase in value for the next three years, which at the end of the same period you have paid $194,500 of your $200,000 mortgage. You don’t have to perform any complicated calculation in order to see that your ROI for this kind of investment is simply lousy, to say the least.
Now, let us consider the situation with the other alternative – going for a lease-purchase. Let us assume that you have the opportunity to make a lease-purchase offer for a home worth $250,000. Your proposal is a full price of $250,000 lease/purchase with monthly rental of $1,600. You also propose 25% of total rental payments be credited to your purchase of the property and give them $3,200 which is equivalent to 2 months rental payment as option consideration, which will also be applied when you finally make the home purchase.
This option will not involve add-on cost for closing, insurance, etc. After three years from your date of move-in, your total equity for the rental property is the sum total of your option consideration and your rent credit which is equivalent to $14,400. Your total equity equals $17,600. For this option, your ROI is equal to 500%.
But there is a catch in our comparison of the two scenarios. The basic difference between the two options is that ownership is not present in the lease/purchase option. However, your equity is basically the same for both options and the difference in your circumstances will not have any effect on your stake in the property, whether you own the property or not. In the first option, you can realize your equity only when you are able to sell the property. In the same manner, you can realize your equity in the lease/purchase option when you decide to exercise the purchase option and sell the property. For the second scenario, your logical move would be to sell your option to purchase before the term of the lease ends.
This is how you can realize your equity from a lease/purchase option. You can exercise your option to buy 6 months before your lease term ends. You can then start advertising the home property for sale. Once you are able to link up with a potential buyer, you simply exercise your option to purchase and immediately sell the same property for profit to your buyer.
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