The real risk to the buyer is that they do not repair their credit and in 3-5 years cant qualify for a loan to fully pay of the Seller. The other problem is if the agreed purchase price is higher than the appraisal the Buyer wont be able to pay of the note. In both cases, the Seller throws out the Buyer and keeps all their money.
To protect the buyer, their monthly payments must be run through an escrow company. This escrow company charges approximately a $15/month fee. The escrow company receives the Buyer's monthly payments and makes payments to the Seller's lender, pays taxes, insurance, HOA, etc and the balance goes to the Seller.
This method has real advantages for the Seller, besides earning a good rate of return. If the Buyer defaults the seller gets to keep all the Buyer's money. And they can take possession of the property in as little as 30-180 days (the time is governed by the amount of equity the Buyer has in the property as set by state law). This in most cases is even faster repossession than the Deed foreclosure process here in Arizona.
This type of transaction should only be done, but only by highly experienced real estate agents or real estate lawyers. If not done correctly the buyer can find that they proceeded in good faith, but they lose all their money.
An alternative to consider is to use a "reasonable" hard money lender if you have a substantial down payment. Put in 35% down payment required, pay your 8% interest, buying the house at today's fair market price getting a Deed. The buyer has some of the same risks (like not being able to finance in 3 years) but these risks may be less then a contract for deed.
Central AZ Real Estate
Your Local Expert
Make sure you fully understand all the parts to a lease with the option to buy agreement,
Now, granted, there can be creative contracts, but.........generally speaking, the following occurs:
1. the purchase price is agreed to at the beginning of the transaction - do you really want to set a price for 3 years down the road?
2. The portion of the rent that will be applied to your down payment, SHOULD you buy the home, is usually a amount OVER and above the fair market rental amount.............you don't get to have , say, 1/3 of the typical rent held in savings............the landlord usually gets his normal rent, and you, the tenant, pay an amount over that ...that higher amount is the amount you will be credited with.....or, you can come up with this non-refundable option money on your own ahead of time.
3. IF, and this is a big IF.....you do not qualify for a loan and cannot obtain a motgage, and buy the home, you LOSE that upfront "option" money........it is forfeited and is non-refundable!
You see, the seller has to sell to you at the agreed-upon price, but you do NOT have to buy..........you DO however, have to pay some non-refundable "option" money in order to have that right to buy.
Taking the above into consideration........you better make darn well sure you will be able to get a mortgage in the future, and will be able to complete the purchase.
You also better make sure the seller doesn't default in any way and lose the house, or you may also lose your money.
You should write in a clause that says the house must appraise out for the agreed upon price, but..........who know what the market will be in 3 years?
Forget the creative contract..................rent and save up your down payent while repairing your credit.........THEN, find a house to buy (you also don't know what the mortgage rates will be in 3 years - maybe higher raes will keep you from being approved, who knows!)