A rent-to-own agreement allows would-be home buyers to move into a house right away. With several years to work on saving for a down payment before trying to get a mortgage. Here’s all you need to know about Rent-to-Own.
Rent-to-own allows prospective buyers to lease a property with an option to buy. A rent-to-own agreement is a deal in which you commit to renting a property for a specific period; with the option of buying it before the lease runs out.
How Does Rent-to-Own Work?
In their contract, the buyer and seller agree on the price to be paid for the house. Regardless of the home’s value, the buyer can acquire it for that amount soon. To take into account anticipated gains in home values, rent-to-own home prices frequently exceed market rates. The buyer benefits if the home’s value has increased more quickly than anticipated. The tenant may leave if the house’s value drops. When the time comes to buy the house, buyers typically apply for a mortgage.
Buyers typically pay an option premium upfront or in equal increments tied in with their rent payments; often up to 5% of the ultimate purchase price. The payment is non-refundable, but it can be applied to the down payment.
Contracts also establish the amount of monthly rent plus the extra amount the renter pays each month. The additional amount is usually credited to the final purchase price, so it reduces the amount of money the buyer has to come up with when buying the home. The extra rent is nonrefundable. It compensates the seller for agreeing not to sell the property to anyone else until the agreement with the renter ends. Contracts should also stipulate who is responsible for maintenance during the rental period.
Is Rent-to-Own Worth It?
Rent-to-own agreements make sense for some buyers, but not for others. If you have shaky credit or need time to save a down payment, rent-to-own may be the right choice for you. A lot depends on your finances and the state of the housing market.
Pros and Cons of Rent-to-Own for Buyers
- Buy with bad credit: Buyers who can’t qualify for a home loan can start buying a house with a rent-to-own agreement. Over time, they can work on rebuilding their credit scores, and may be able to get a loan once it’s finally time to buy the house.
- Lock in a purchase price: In markets with increasing home prices, buyers can get an agreement to buy at today’s price with the purchase taking place several years in the future.
- Test drive: Buyers can live in a home before committing to buy the property. They can learn about issues with the house, and any other problems before it’s too late.
- Move less: Buyers who are committed to a home and neighbourhood (but unable to buy) can get into a house they’ll eventually buy. This reduces the cost and inconvenience of moving after a few years.
- Build equity: Technically, renters do not build equity the same way homeowners do. However, payments can accumulate and provide a substantial sum to be put toward the home’s purchase.
- Forfeiting money: Something you need to know about rent-to-own agreements is that if you don’t buy the home, you lose all the extra money you paid. Sellers may be tempted to make it difficult or unattractive for you to buy so they can pocket your investment.
- Slow progress: You might plan to improve your credit or increase your income so you’ll qualify for a loan when the option ends, but things might not work out as planned – you should know this about rent-to-own agreements before starting out.
- Less control: You don’t yet own the property, so you don’t have total control over it. Your landlord could stop making mortgage payments and lose the property through foreclosure, or you might not be in charge of decisions about major maintenance items. Likewise, your landlord could lose a judgment or quit paying property taxes and end up with liens on the property. The agreement should address all these scenarios. The landlord isn’t allowed to sell while you have an option on the property, but legal battles are always a major headache and expense.
- Falling prices: Home prices might fall, and you might not be able to renegotiate a lower purchase price. Then you’re left with the option of forfeiting all your option money or buying the house. If your lender won’t approve an oversized loan, you’ll need to bring extra money to closing for a down payment.
- Late payments hurt: Depending on your agreement, if you don’t pay rent on time, you may lose the right to purchase, along with all of your extra payments. In some cases, you keep your option, but your extra payment for the month is not counted, and won’t add to the amount you’ve accumulated for eventual purchase.
- Home issues: There might be problems with the property you don’t know about until you try to buy it—such as title problems. Treat a rent-to-own purchase like a real purchase. Get an inspection and title search before diving in.
Before You Sign the Contract
Here are some extra things to know when you’re considering a rent-to-own property? Be sure to:
1. Choose the Right Terms
2. Get Help
Hire a qualified real estate attorney to explain the contract and help you understand your rights and obligations. You may want to negotiate some points before signing or avoid the deal if it’s not favourable to you.
3. Research the Contract
Make sure you understand:
- The deadlines (what is due when)
- The option fee and rent payments–and how much of each applies toward the purchase price
- How the purchase price is determined
- How to exercise your option to buy (for example, the seller may require you to provide advance notice in writing of your intent to buy)
- Whether pets are allowed
- Who is responsible for maintenance, homeowner association dues, property taxes, and the like
- What “maintenance” means: just mowing the lawn and raking, etc. or serious repairs, such as fixing a roof.
4. Research the Home
- Order an independent appraisal
- Obtain a property inspection
- Make sure the property taxes are up to date
- Ensure there are no liens on the property
5. Research the Seller
Check the seller’s credit report to look for signs of financial trouble and obtain a title report to see how long the seller has owned the property—the longer they’ve owned it and the more equity, the better.
6. Double Check the Fine Print
Another thing you need to know about rent-to-own agreements is the conditions under which you might lose the property you’re trying to buy. Under some contracts, you lose this right if you are late on just one rent payment or if you fail to notify the seller in writing of your intent to buy.
How Is Rent to Own Different Than Buying a House?
Renting to own is a hybrid approach to buying a home where all or a portion of a lease payment goes to building equity in a home over time. It is usually a process by which the owner of a home allows a renter to build equity without having to make a down payment or secure a mortgage.
What Are the Advantages of Rent-to-Own Agreements?
Renting to own can allow a person to begin building equity in a home they like without having to take out a mortgage or come up with a large down payment. This can be especially beneficial for those without the financial means to make a down payment due to a lack of savings or qualify for a mortgage due to low credit scores.
- You should know that Rent-to-own contracts allow prospective homebuyers to lease a property with an option to buy.
- The contract gives the renter the option to buy the home at a specified point in the future.
- Part of the monthly rent goes toward the purchase price of the home, allowing the leaseholder to save toward the down payment.
- Buyers typically pay a nonrefundable premium upfront, often up to 5% of the purchase price.