Rent to Own Homes—The Basics
Have you been hearing about the potential to rent to own? Lots of people wonder how rent to own purchases work. You have probably seen advertisements for rent-to-own properties at one time or another. While these arrangements are not common, they do appear from time to time and may appeal to you if you are not quite ready to buy a home in a traditional manner.
But how do rent to own deals work? Are they a good idea? The more you know about rent to own arrangements, the better equipped you will be to decide if rent to own is the right fit for your real estate goals.
Quite a few folks try to decide between renting and buying a home. A rent to own scenario can end up being the best of both worlds. Let’s take a look at the pros and cons of renting to own both from the owners’ and tenants’ perspective.
The Traditional Home Buying Process
Let’s look at the basics of a traditional home purchase first for comparison. Most homebuyers follow the same process when they buy a home. They hunt for a home that they like and then make an offer on that home. Once the offer is accepted, the buyer typically engages with a professional home inspector and has the property inspected.
The home inspection is a great way to find out whether you are buying a lemon or not. Once the home inspection is completed, and they wish to proceed, a buyer will work on getting a mortgage from their lender. Once the mortgage commitment is in place, they pay the home seller at a closing and obtain the title transferred from the seller to themselves.
Usually, a home sale takes between one and two months to complete when financing is involved. If the home is purchased for cash, it can take as little as a week or two. Quite often, in a traditional home purchase, the buyer has been renting and decides that homeownership is the right move at the present time.
The Rent to Own Home Buying Process
With rent to own, the home buying process stretches out over a much more extended period. The buyer finds a property owner who is willing to enter into a rent to own agreement. The buyer and seller negotiate an arrangement where the buyer can live in the home and pay rent for a specified period, with a portion of the rent going toward the down payment on the house.
At the end of the specified time period, the buyer will either have the option to buy or not buy or will be required to purchase the home (more on this later).
Why Would Someone Rent to Own?
Not everyone is ready to buy a home. You have to have good enough credit to get a mortgage. In most cases, you have to come up with a down payment unless you are a veteran and can procure a Veteran’s mortgage or are buying in a rural area and can get USDA financing. When purchasing a home for the first time, it is essential to brush up on the financing programs available for first-time homebuyers.
These are financial hurdles that may take time for you to overcome. But if you know you want to be a homeowner, or you would at least like to have the option in the future, you could find a rent to own deal and start down the path towards your goal.
Maybe you have identified a home that you’ve driven by quite often and always loved it? Perhaps you also have found out the owner is up in the air about selling or renting. A “rent to own” in this situation could be the best of both worlds for you and the owner.
What You Need to Pay Attention to With Rent to Own
There are no hard and fast rules with rent to own.
Unlike traditional real estate transactions, rent to own arrangements are more personalized and flexible. This can be a good thing or a bad thing. It can be a good thing when you make an arrangement with the seller that is fair and beneficial to you.
It can be a bad thing if you do not pay attention to the contract you sign—because you can quickly get yourself into a deal with unfavorable terms where you see little to no benefit, and the seller sees all the positives.
You will need to negotiate a leasing to own contract.
All real estate transactions involve contracts, and rent to own is no exception. You need to do your homework to make sure you understand what should be included in the contract and what the terms should look like.
You are negotiating a business deal, so you need to be careful. It is an excellent idea to hire a real estate attorney to look over the contract and explain it to you, so you avoid entering into a deal that you do not understand.
Know your contract terms and how they will affect you.
There are several terms of the contract that you will need to pay close attention to. These include:
- Lease term. The lease term defines how long the lease will last before you will need to buy the home or move out. You and the seller can agree to any lease term you like. Most rent to own lease terms range from one to three years. Be realistic about how long it may take you to get ready to buy—including repairing your credit and saving up for a down payment. A one-year lease term may not be long enough for you to get your finances in order.
- Option fee. This is the fee you are going to pay the seller for the option to buy the home. The option fee is usually something you can negotiate. Typically, the cost will range between 2 percent and 7 percent of the purchase price of the home, although it can be lower or higher depending on your individual circumstances. Sometimes the option fee can be applied to the purchase price of the house, again depending on what you negotiate with the seller.
- Lease option or lease purchase. You have two different options when it comes to a rent to own agreement—a lease option or a lease purchase. You want to be confident what your contract says here because there is a big difference between the two. A lease option means you will have the right to purchase the home at the end of the lease. You can buy or not buy it. A lease-purchase agreement means you are legally obligated to buy the house at the end of the lease. If you do not have the financial means to buy the home or do not want to buy the home at the end of the lease, a lease-purchase agreement will put you in a challenging position.
- Rent credit. In a rent to own agreement, it is standard for some portion of your rent to go towards the down payment on the home. Usually, the rent credit ranges between 10 percent and 25 percent, but again, it all depends on what you negotiate with the seller. There are no hard and fast rules for the rent credit. You should insist that the rent credit is kept in an escrow account to protect you and the seller.
- Purchase price. Some rent to own agreements establishes the purchase price when the contract is written at the beginning of the lease. Other contracts state that the fair market value will be determined at the time of purchase. Either way, you want the decision on the purchase price in the agreement.
- Maintenance. You can negotiate who is responsible for property maintenance, both everyday maintenance like mowing the lawn, and significant maintenance like replacing the roof or the HVAC system. Major maintenance is expensive, so be careful about what you agree to. Either way, you should get a home inspection before signing the agreement.
Leasing to Own: Pros and Cons For Buyers and Sellers
In the majority of leasing to own situations, the bulk of the advantages are on the homeowner’s side. However, there are still some advantages for the renter turning home buyer.
Advantages for the seller:
In a buyer’s real estate market, it can be an excellent opportunity to increase cash flow from renting a property that was otherwise vacant or difficult to sell. Most rent-to-own arrangements are long-term, and the rental rate can be higher than average, an advantageous arrangement for property owners.
Advantages for the buyer:
Rent to own agreements essentially allow a buyer a few years to work on improving their credit score as well as saving additional funds to go towards a down payment. If a lease option to purchase agreement has the selling price of the house, that price is locked in even if real estate values go up.
Disadvantages for the seller:
You will not be able to sell the house if the real estate market improves, and you are still within the terms of the contract signed. If the agreement includes the sales price, you will not be able to raise the price. If the buyer backs out and doesn’t improve their credit, you’ll be back to the drawing board and be stuck with a vacant rental.
Disadvantages for the buyer:
If you don’t increase your credit score, you could lose the option fee and the years of extra rent paid. Also, it’s possible something out of your control could happen; for instance, a job loss or a severe illness which could prevent you from buying.
As you can see, there are both pros and cons with rent to own for a buyer and seller.
What Can Go Wrong in Rent to Own Arrangements?
Besides the above pros and cons of rent to own agreements, there are other things you should be cautious of both as an owner and a renter. Here are some considerations to think about before entering into one of these agreements:
- The owner of the house doesn’t pay their mortgage or taxes, putting themselves into the position of being foreclosed on.
- The renter doesn’t treat the property as well as you do – letting all of the maintenance go, devaluing the property.
- While living in the property, the renter discovers problems in the house that make them not want to move forward.
- The owner passes away before the completion of the agreement complicating the transaction.
- The contract is terminated because rent is consistently paid late and the renters lose their investment.
- It’s possible a homeowner could try to sabotage the agreement so that they can sell their property for more than the stated contract.
While these are the “worst of the worst” things that can happen, it’s always essential to have them on your radar whether you are the buyer or seller.
Avoid Lease Purchase Agreements
There is a lot of flexibility in rent to own agreements—you and the seller can find terms that you both think are fair. But of all the terms you should avoid, lease-purchase agreements are the most important.
It is not a good idea to lock yourself into a purchase that won’t occur until years down the line. Many things can change, including your financial situation, so steer clear of lease-purchase agreements if at all possible.
Vital Takeaways of Renting to Own a Property
- A rent-to-own transaction is a contract that you commit to renting a house for a specified period of time, with the option of purchasing it before the lease runs comes to its conclusion.
- Rent-to-own agreements usually include a standard lease agreement as well as the option to buy the house in the future.
- Lease-option contracts allow you the right to buy the home when the lease expires, whereas lease-purchase contracts make you purchase the property.
- You’ll be paying rent throughout the lease, and in most situations, a percentage of the rent payment is applied towards the sale price.
- With a percentage of rent-to-own contracts, the renter may have to pay for any repairs as well as maintain the property.
Final thoughts on Renting to Own
Rent to own transactions are not common, but they can work in some instances when two parties have unique circumstances. Just be sure you go into this arrangement with eyes wide open. Understand the advantages and disadvantages before making a long term financial commitment.
Hopefully, you now understand how rent to own works and can make an informed decision based on all of the pros and cons whether you are a landlord or renter.
Additional Helpful Real Estate Resources
Get more trustworthy advice and tips from other real estate professionals.
- What can go wrong buying a new home – see some of the common pitfalls that can crop up when buying a newly constructed home. Know what problems to avoid when buying new construction.
- Things to know before buying a house – learn some basics about buying a home that is essential, so you don’t make a critical mistake. Making mistakes are relatively common but avoidable when you go from renting to buying for the first time.
- Understand these home inspection tips – be sure you make sound decisions when it comes to getting a house inspected.
- Smart things to ask when purchasing a condo – see some must asking questions when you are buying a condo for the first time. Buying a condominium in some respects is a lot different than purchasing a house.
Use these resources from top real estate agents to make the best home-buying decisions.
Article Courtesy of Bill Gassett, August 12, 2019