I had a phone call the other day from a borrower who was approved for an ACORN Loan.  His problem was that the loan they were offering him was questionable at best.

He has credit issues but he also has some money saved for the down payment ($10,000). Oh, and he's self employed.  He has marginally squeaked into a loan approval - (but that doesn't mean they still won't decline him).  His approval was with someone else.  This is the first time I've talked to him.

His Agent had him call me.  He was now looking at a Lease Option and she wanted me to advise him.  The home is out of our area (Tracy, CA) so she couldn't provide either of us quality information without MLS access.

The story goes like this:

He finds this Lease Option on Craigslist.   The home is being represented by a licensed Agent.  He detailed some of the terms required in this lease.

• $10,000 Down.
• $1,600 a month rent.
• 1 year term.
• The Agent told him the property is valued at $536,000.
  

At the end of 12 Months he can purchase the property for $519,000.

Sound OK?

But the property is Tracy, and area of enormous concern.  Is the property really worth $536,000 now?  I doubt it. For all I know the home could be worth $400,000 right now.  Home values in Tracy have certainly declined and they are not showing any signs of slowing.  Was the property previous listed?  We think it may have been. For how much?  They didn't tell him and in truth, we didn't even get to that part of the conversation.

Foreclosure rates are also very high.  How about a year over year increase of 193% this past quarter!  In past years the housing boom in the Bay Area funneled many new home buyers to Tracy.  Tracy was "more affordable".  Those buyers have questionable loans now and as the recasting hits, more and more will be forced into default.

On a loan-by-loan basis, mortgages were least likely to go into default in Marin, San Francisco and San Mateo counties. The likelihood was highest in Sacramento, Riverside and San Joaquin counties.

And then here is a newspaper story on the local economy in the central valley, from the Sacramento Bee

Because of low incomes, the Valley is especially vulnerable to the downturn. Nearly 22 percent of all Merced home mortgages as of December were subprime loans, the highest in California and seventh highest in the nation, according to First American LoanPerformance. The U.S. average was 15 percent.

Many of these loans are ticketed for disaster: The nonprofit Center for Responsible Lending predicted 25 percent of the subprime loans taken out in Merced during the first nine months of 2006 will result in foreclosure. Bakersfield, Stockton, Fresno and Visalia won't be far behind, the center predicted.

Two paths will happen in a year...

1. He'll rent and walk away, he'll be out $10,000 in savings and have spent $19,200 in rent.
2. Or, he will buy the property.  If he decides to buy his "Rent to Own", they'll sell it at $519,000 and give him $29,200 (his deposit + 12 rental payments) towards closing.

My Crystal Ball is in the shop for a tune up, but I have to wonder...

• What will rates be like in June 2008?
• Will his credit be any better then?
• What will underwriting guidelines be like in June 2008?
• Will he be able to qualify for anything at all?

My initial thought, and my advise to him was to not consider a Lease Option especially in a declining area / declining market.  He's taking on all the risk, not the seller.  If at all, the seller is hedging their position while looking at a very questionable future.

I was thinking this isn't a bad idea for those who have listings that won't sell.   Looking at it from the Seller's perspective, if the cash flow is neutral at best, they can wait out a year of market correction.  In a year if the renter walks, and the market goes up - they took his $10,000 and now get to list in a better market.

If the market goes down, and the buyer buys - they really make out!

Of course the market could also drop and the buyer could walk, but then they still have the $10,000 to offset a loss.

I don't see this as a Win - Win anyway it turns out. 

What would you do?