Rent-to-Own Housing Contracts Under Financial Constraints

29 Pages Posted: 21 Mar 2015

See all articles by Sanjiv Jaggia

Sanjiv Jaggia

California Polytechnic State University - Orfalea College of Business

Pratish Patel

California State Polytechnic University, San Luis Obispo - Finance Area

Date Written: March 10, 2015

Abstract

Due to tougher lending standards, Rent-to-Own (RTO) contracts are getting popular. In a RTO contract, a tenant signs a lease with the option to buy a house at a predetermined purchase price. That is, the tenant receives a call option. RTO contracts allow potential financially constrained homebuyers to lock in a price while they use the time to build up savings and creditworthiness. Even ex-chairman Bernanke has endorsed RTO contracts as a tool to stem foreclosures. Despite recent interest, the economic implications remain murky. Contract terms are further complicated since the tenant may stay financially constrained, and not qualify for a mortgage, in the future. In this paper, we analyze the economics of a RTO contract under financial constraints in competitive equilibrium. We show that the equilibrium purchase price is extremely sensitive to the tenant's financial constraints. This information is useful in negotiating contract terms for an interesting new development in the real estate industry.

Keywords: Housing lease Option, Mortgage Requirement, Homeownership, Rent to Own, Credit tightening, Esscher Transform

Suggested Citation

Jaggia, Sanjiv and Patel, Pratish A., Rent-to-Own Housing Contracts Under Financial Constraints (March 10, 2015). Available at SSRN: https://ssrn.com/abstract=2576485 or http://dx.doi.org/10.2139/ssrn.2576485

Sanjiv Jaggia

California Polytechnic State University - Orfalea College of Business ( email )

United States

Pratish A. Patel (Contact Author)

California State Polytechnic University, San Luis Obispo - Finance Area ( email )

College of Business
San Luis Obispo, CA 93407
United States

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