Are you tired of renting, basically “throwing away” your hard-earned money each month on rent, wishing that money could go towards a mortgage? You want to own a home, but do not have much extra money for a down payment or have a hard time qualifying for a traditional mortgage loan. No doubt you have heard of an alternative purchase option known as rent-to-own.
Are the rent-to-own options really as great as they seem? This solution to home buying can have potential risks and be a bit more complicated than the traditional route of financing and purchasing a property. There is a dirty little secret about the rent-to-own process that you need to know about.
Rent-To-Own Contract Options
There are a couple of options to consider before going into a rent-to-own agreement. With a lease-option agreement, the tenant has the option to buy the home at the end of the standard rental agreement. This is typically the more preferred rent-to-own deal.
A lease-purchase agreement is another type of agreement that legally obligates the tenant to purchase the property at the end of the lease terms agreed upon. This binding rent-to-own contract is much riskier and the potential buyer needs to be certain he or she will purchase the property, or the loss can be costly.
The buyer and seller negotiate the purchase price with the signing of the lease agreement and in some cases, at the end of the lease period. In most cases, the rental term for a rent-to-own lease is one to three years. The buyer must present funds to pay the seller an upfront payment or option fee, also known as option money or option of consideration. This is usually 1 to 7 percent of the agreed-upon purchase price.
In addition to the monthly rent payment, the buyer pays a Rent Premium or Rent Credit. This extra amount credited toward the purchase price of the home makes the monthly payment higher than what the normal rental rate would be. It is important to know what you are paying and to be sure the extra you are paying will be credited to the purchase price.
Potentially How the Rent-to-Own Model Works
Let’s see how a typical rent-to-own agreement would work out. For example, let’s say that the rental rate for a 3 bedroom, 2 bath house is $1,500. Now the additional amount that you will pay towards the purchase price is negotiable. Generally, you should expect to pay 20% to 50% above the market rent. For the sake of argument, let’s go with 25%, which is about average. So you will pay $1,500 a month in rent and an additional $375 towards the purchase price. If your lease period lasts 3 years, you would have a $13,500 credit. If the purchase price is $280,000 and if you paid a 3% option fee of $8,400 and combined that with the credit, you would end up with a down payment of $21,900 or 7.8%.
Review the Contract Carefully
Depending on the lease agreement, many rent-to-own properties place the repair and maintenance responsibilities in the hands of the lessee. In a typical lease agreement, the landlord will cover repair, maintenance, and other preventative care costs for the property. It is also important to be aware of who is responsible for paying costs and fees such as HOA dues, home insurance, and property taxes. Review the contract carefully so you are not put in a bind when due to unforeseen circumstances – anything can happen!
If you decide to buy a rent-to-own property, make sure that you understand exactly what your monthly and extra payments will be before signing any documents. Talking with a real estate agent about a potential rent-to-own purchase is also highly recommended.
Here’s the Catch
Do you want to know the dirty little secret that prospective buyers in rent-to-own deals realize? If the buyer is unable or unwilling to buy the house at the end of the lease agreement, the buyout option expires, and ALL of the money paid towards the rental payments and purchase funds is forfeited. That includes the Rent Premium and the option fee.
This is not an uncommon issue. The prospective buyer may run into some problems with the house and decide that he or she would rather purchase the home. In some cases, the buyer may not be able to qualify for a mortgage. It is even possible that the seller fails to pay the mortgage and the property goes into a foreclosure process. All of these scenarios result in the potential buyer forfeiting funds paid.
Pros and Cons to a Rent-To-Own Option
There are real risks to renting to own, and it is certainly not a great option for all prospective homeowners. Before you consider a rent-to-own arrangement, be sure to explore all pros and cons of these agreements and understand the type of contract that would be best for you.
Pros to rent-to-own agreements include saving up money for the down payment and purchase costs and setting oneself up well to be in a good position to qualify for a mortgage by the time the purchase option is available. If your credit score is on the lower end, evaluate your credit history and continue to rent while you work to improve your credit score.
Keep in mind is the amount of cash you will have ready to go for the down payment when it will be unlikely that you will be able to have enough for a down payment based solely on the rent premium you pay each month. This means that you will need to be able to save additional funds to meet lender down payment requirements.
There is no buyer competition with rent-to-own contracts. Therefore you will not be setting yourself up for a bidding war of offers with other prospective buyers.
The cons to rent-to-own agreements include having a higher monthly payment than paying a normal rental rate or mortgage payment, and in addition to that payment, you could likely be in charge of repairs and other monthly charges. Of course, loss of funds paid on the option fee and monthly rent premium is another con if the deal does not work out for any reason.
Rent-to-own certainly is not for everyone. Before you race to snap up the closest rent-to-own lease property, make sure you are ready and willing to see the contract through to the end. Do your research on the local real estate market and speak with a knowledgeable real estate broker before jumping into any risky contracts.