How Rent-to-Own Works
Affording a home can be difficult, leading many Americans to seek out alternatives to taking out a mortgage the traditional way. Rent-to-own agreements are one method that has enabled some families to finally achieve their dreams of homeownership, but before entering one of these arrangements, it’s important to be aware that there’s more to them than meets the eye.
What is rent-to-own?
A rent-to-own agreement is an arrangement in which you rent a house for a set period of time and then buy it after that period ends. You and your landlord agree on a fair purchase price for the property, and at the end of your lease, you can buy the house for that price.
Renting to own is a bit more expensive than a traditional lease because the renter is effectively paying for the opportunity to buy the property they are currently occupying before anyone else gets the chance.
What types of rent-to-own contracts are available?
Rent-to-own contracts come in two varieties: lease-purchase and lease-option.
In a lease-purchase agreement, you agree to rent a home for a set lease period—usually 1–3 years—before buying. At the beginning of your lease, you and your landlord decide on the price you will eventually pay for the house, which is usually determined based on an appraisal by a third party. During your lease, your rent payments will become more expensive, with the extra money you pay going towards your eventual down payment on the house. Then, at the end of the lease, you will be legally required to buy the home.
A lease-option contract works similarly to a lease-purchase contract, but with a couple key differences. When you enter a lease-option agreement, you’ll need to make a one-time payment of approximately 2–7% of the home price you and your landlord decided on. This payment is called an option fee because it gives you the option to back out of buying the home if you decide later on that it’s not right for you. Of course, it’s still in your best interest to go through with buying, since the option fee will go towards your down payment if you buy the property, and you won’t get the money back if you don’t buy it.
What are the pros and cons of renting to own?
While rent-to-own agreements can provide an excellent path to homeownership for some renters, they do come with some serious drawbacks, making them far too risky for many aspiring homeowners. Before entering a rent-to-own contract, be sure to weigh the following pros and cons.
Renting to own may enable you to save up for a home if you don’t have enough money to qualify for a mortgage right away.
Rent-to-own agreements allow you to call “dibs” on the home you’re renting, so no one else has the opportunity to buy it before you.
If you aren’t certain whether or not you want to commit to a home, entering a lease-option contract enables you to take the property for a “test drive.”
Renting one home and then buying another one means you’ll have to spend time and money moving your furniture when you relocate. In a rent-to-own agreement, you won’t need to worry about the hassle of moving because all of your belongings are already in the house.
In the event that you aren’t able to qualify for a mortgage at the end of your lease—as is the case for most renters—you’ll have wasted all the extra money you spent on your rent payments and your option fee. Plus, if you entered a lease-purchase agreement, your landlord can file a lawsuit against you.
Rent-to-own agreements require you and your landlord to set a buying price at the beginning of the contract, but it’s impossible to predict exactly how much the house will be worth later on. It’s entirely possible that at the end of your lease, the home’s value will have decreased, and you’ll be paying more for it than it’s actually worth.
Some rent-to-own contracts may require you to pay for property maintenance during the course of your lease. So if the home needs costly repairs, you’ll need to pay for it.
Who can benefit from a rent-to-own agreement?
While traditional mortgage arrangements work best for many home buyers, renting to own may be an option worth exploring if you’re in one of the following situations:
You don’t have adequate funding to qualify for a mortgage or make a down payment on a house just yet, but you will have enough saved up in a year or two.
Your credit score isn’t high enough to get a mortgage at the moment, but you know you can improve it significantly over the course of your lease.
You have enough money to buy a house, but you can’t prove your qualifications to a mortgage lender. This may be the case for you if you are self-employed, work on commission-based pay, or don’t have an established credit history.
You struggle to budget properly when saving up for a house, and having a contract forces you to put money aside and keep your spending in check.
You love the property you’re renting and would rather continue living there than find a new home that might not be a good match for you.
Of course, even if one or more of the above applies to you, that doesn’t necessarily mean that renting to own is the best decision for you. Remember that rent-to-own contracts do not work out for the majority of people who enter them, so this isn’t a decision to be made lightly.
What should you consider before entering a rent-to-own contract?
As with any other legally binding contract, it’s important to read the fine print before signing off on a rent-to-own agreement. As you go over the terms and conditions of your contract, ask yourself the following questions:
Is the contract lease-purchase or lease-option?
If the contract is lease-option, will I be required to provide advance notice of my intent to buy?
How much will I be expected to pay for rent, the option fee, and the final purchase price of the home? How are these prices determined? Are they fair compared to other similar properties?
What deadlines do I need to adhere to? Will I lose the right to buy the house if I am late on any rent payments?
Will I be responsible for property maintenance during the course of the lease? If so, what does the contract define as “maintenance”?
Is this property part of a homeowners association? If so, what are its rules?
Is there anything wrong with the property, such as extensive damage or liens?
In addition to considering the points above, you should also thoroughly vet your landlord to make sure they are a reliable seller. Conduct a background report to check their trustworthiness and have a title search done to confirm they are the legal owners of the property.
Should I enter a rent-to-own agreement?
The problem with rent-to-own agreements is that you can’t see the future, and no matter what your financial situation is now, there’s no way to be completely certain what your income and credit score will be in several months. The reality is that most people who enter rent-to-own contracts are not able to qualify for a mortgage at the end of their lease, and that will likely be the case for you as well, no matter how attractive the arrangement may seem.
Renting to own only works if you are extremely confident that you’ll be approved for a mortgage at the end of the contract, and even then, there’s always some risk involved. Keep in mind that if your plans end up falling through, you’ll have sacrificed a significant amount of money at best, and put yourself in serious legal trouble at worst. Proceed with caution.
If you’re considering renting to own, or looking for another alternative to taking out a mortgage the conventional way, BuyHouseEZ can help you. We specialize in assisting homebuyers in non-traditional circumstances, and we can help you explore your home financing options even if you don’t qualify for a standard mortgage. Contact us today to get started!