Outside of buying a home, there is another viable way an individual or couple can obtain ownership of real estate known as rent to own. Though rent to own homes are less common arrangements, this is a viable way for many to achieve the dream of owning a home.
Unlike a standard renting agreement, rent to own provides a means to own property for those unable to secure financing, so long as certain conditions are satisfied.
Here, we’re going to cover the basis of how rent to own works and provide some pointers for those seeking this kind of arrangement.
What Does Rent to Own Mean?
Think of rent to own as a marriage between renting and buying, with a few twists. You lease a property with the option (or obligation, depending on the agreement) to eventually purchase it, often after a predetermined period. Part of your rent goes towards a down payment, building some equity as you live in the space.
Similar to buying, rent to own homes typically include an upfront fee known as an “option fee” that acts as a kind of down payment – it’s usually between 2% and 7% of the home’s value (or agreed upon purchase price). Prior to buying the home, the tenant will be under a lease contract or rent to own agreement, much like renting, with the exception that monthly payments (or a portion of them) are allocated toward the down payment.
If the home is purchased within the agreed-upon timeframe, payments made by the lessee are applied toward the purchase. However, if the lessee fails to purchase the home or secure financing, payments toward the property are lost, along with the option fee, in most cases.
The Caveat: What is the Main Reason to Avoid Renting to Own?
With rent to own homes, most of the risk falls on the potential buyer as contracts typically provide the seller with several mechanisms that allow them to keep funds paid should issues arise at any point during the process.
The phrase “rent to own” is also frequently used in scams to take advantage of this seemingly attractive pathway towards ownership.
Of course, there are plenty of valid rent to buy homes across the country at any given time – but properties should always be approached with caution before signing any kind of agreement.
Pros: Paving a Path to Homeownership
Despite the potential pitfalls, there are plenty of reasons to consider rent to own homes.
- Rent to buy houses typically boost credit scores. While traditional renting doesn’t boost your credit score, rent to own agreements often report your on-time payments, potentially giving your score a much-needed bump.
- It offers a clever way of saving for a house downpayment. Those accumulated rent credits act as a saving grace, helping you bridge the gap towards that essential down payment, inching you closer to homeownership.
- You get to know the property. Before committing to a permanent purchase, a rent to own arrangement lets you live in the house first-hand, ensuring it truly fits your needs and lifestyle. This is one advantage over a traditional purchase as buyers have an opportunity to learn about the property before completing a sale.
- It’s more flexible and offers an out. This structure can be a lifesaver if you need extra time to improve your credit, save more, or secure a stable job before the purchase deadline. If you decide not to buy, you’re typically only out as much money as you would have spent on renting throughout the same duration.
Cons: Beware the Potential Potholes
As we stated, rent to own homes aren’t ideal for everyone.
- Potential for lost investment: This is the harsh reality – if you decide not to buy the property at the end of the lease, your option fee and rent credits are forfeited.
- Rent credit is usually limited contractually. Make sure to fully understand the “down payment-building” conditions of a rent to own agreement. Typically, only the last year’s worth of rent is actually applied toward your down payment.
- Mortgage approval isn’t guaranteed. If you can’t secure financing at the end of the lease, you lose everything and move out empty-handed. For those who are nowhere close to obtaining a mortgage, it’s uncommon to be in a position to buy after a typical 12-month rent to own agreement.
- Higher can mean higher risk. Expect to pay more than the market rate, as part of your payment goes towards future ownership. While payments should apply toward the home purchase, it can put a crunch on finances in the interim.
- Possible repair obligations. Depending on the rent to own agreement, you might be responsible for repairs, adding unexpected costs to the budget.
Types of Rent to Own Agreements
There are two primary types of contracts: lease option and lease purchase.
Lease Option Agreement
In a lease option agreement, you pay the homeowner an upfront option fee, typically 2% to 7% of the home’s value. This fee gives you the right to purchase the home at an agreed-upon price after leasing it for 1 to 3 years. During the lease term, a portion of your rent may be credited toward the future purchase if you decide to buy.
Lease Purchase Agreement
With a lease purchase agreement, you commit to buying the home at the end of the agreed-upon period where a portion (or all) of your rent is applied to a down payment. You and the seller agree on the purchase price upfront, which can help you plan for financing. If you fail to secure funding by the end of the lease, you lose the accumulated rent credit and may face legal action from the homeowner.
Choosing between a lease option and a lease purchase for rent to buy houses depends on your financial situation and commitment level. A lease option offers more flexibility, allowing you to opt out of the purchase, while a lease purchase requires you to buy the home. As such, it’s crucial to consult with a real estate professional before making a decision.
How Does Rent to Own Work?
Ignoring the potential obstacles, the process of rent to own itself is quite simple.
- Agree on a purchase price: Negotiate the purchase price upfront, which may be fixed or adjusted based on market conditions.
- Review and sign the agreement: Carefully review the lease option or lease purchase agreement, noting details like the rental period and responsibilities.
- Pay the option fee: Upon signing, pay the option fee, typically 2% to 7% of the home’s purchase price.
- Make rent payments: Start making monthly rent payments, often higher than the market rate, with a portion of (or all) funds allocated to your future down payment.
- Apply for a mortgage: Before the end of the rental period, apply for a mortgage if you decide to purchase the home. If you signed a lease purchase agreement, you’re legally obligated to buy the home, so long as the seller hasn’t breached a portion of the contract.
Though less than conventional, proper rent to own homes can help those who want to own a home achieve their goals. Like any real estate venture, make sure to consult with an attorney to minimize risks.
