For many Americans, the purchase of a home is a milestone in life. But this might not be so for everyone. In fact, the rising inflation of the real estate market lately has made this a difficult option to obtain even for those who do wish to pursue this dream.
If you are one of this growing number of people, who may not be able to afford the upfront costs of taking on a mortgage, there is another way that could end with you owning your own home.
A rent-to-own home is a contract that you enter into with a landlord where you agree to rent a property for a length of time with the option to buy that same property later. As the renter (or future homebuyer), you negotiate the terms of that contract with the landlord (and future seller) and pay rent per month the same as you would with a typical rental home.
However, a portion of that rent gets credited toward the purchasing price of that home. And, once the contract expires, you have the option to either buy the home or renew your contract.
In this article, we’re going to discuss the three most important things that you need to know about rent-to-own homes. Let’s dive in!
But before we move forward, we need to ask you one thing: are you ready to start living your dreams and get into a home? If you’re a first time home buyer, we actually have a specialized program for you. Start living your dreams now with The Renter’s Best Friend 1st Time Home Buyer program.
#1: Lease-Purchase versus Lease-Option
First on our list is the difference between these two types of rent-to-own contracts. Both permit you to rent a home for a specified number of years, usually between 1 and 3, and then to buy the home at the end of that lease’s term. However, there is a fundamental factor that separates these two types of lease from one another.
This type of lease means that you are legally obligated to buy the home once the contract expires; meaning you are locked into your decision at the time you sign it. Usually, an overall purchase price for the home is agreed upon in the beginning. This lets you know how much you will need to save for the eventual loan and will give you time to prepare your finances. Typically, this type of contract dedicates a larger portion of your monthly rent toward the home’s eventual cost. If you change your mind about purchasing the home, you could face legal ramifications for walking away.
This type of lease means that, while you will still be granted the right to purchase the property once the agreement ends, you are not forced to. You can opt out of buying the home and walk without any sort of legal consequences. Typically, these leases carry an upfront option fee that is usually between 2 to 7% of the home’s purchase price. Monthly rent for these types of leases tends to be a bit higher. Be aware, if you decide not to purchase the home, the option fee and any rent that you paid while living in the home are forfeited.
#2: The Pros and Cons
Rent-to-own homes offer a compromise between renting and buying, potentially even giving you the best of both options. However, there are still risks and rewards that must be weighed against one another before you make the decision to enter into such an agreement. The second entry on our list will showcase some of the pros and cons of signing a rent-to-own contract. Obviously, some of these factors will depend on the terms of the specific contract you sign, so make sure to also read #3 on our list!
- Time to Build Finances. If you have a lower credit score or not quite enough in your savings to be able to afford a large down payment and closing costs, the period of your rent-to-own lease could give you the time you need to get those affairs in better order. You could take this time to repair your credit, thus lowering your future interest rate on the purchase of the home. Typically, your monthly payments would not be reported to the credit bureaus, but you can request that your landlord do so.
- Paying Down the House. A percentage of what you pay each month is applied to making the down payment on the home. Additionally, depending on the specifics of the lease that you sign, the price of the home is set once it goes into effect. In places where the market may be steadily increasing, this could give you a huge breakthrough that would otherwise be unavailable in the future.
- Lower Upkeep Costs. Many contracts contain a clause that specifies a shared responsibility for the maintenance and repair of the property. While not typical, some landlords are willing to pay for all of the necessary repairs on the home through a certain specified date. Either of these arrangements could mean big savings for you in the short term, but you may also consider that you could be the owner of this home one day. It might be in your best interest to be the person who oversees the repairs and maintenance that will shape your future home for the years and decades ahead.
- Less Additional Expenses. Property taxes can be costly to pay each year, especially depending on the home’s appraised value and where it is located. Homeowner’s insurance is another cost that you will be able to avoid while under a rent-to-own lease, as the owner of the property is who must pay this. While you might want to consider still taking out a renter’s insurance policy to cover your own possessions while living on the property, this is a much cheaper expenditure to pay.
- Keep it Off the Market. Once the lease is signed, the home cannot be sold out from beneath you. If you find a place that you want to call your future home, signing a rent-to-own contract could be a great way to keep it off of the market while you get your finances in order. As an added bonus, you get to move into the home right away.
- Potential Loss of Investment. Depending on the contract and the circumstances, the option fee and any money that you paid in rent are non-refundable. If you decline to purchase the home, back out of the deal, or if something goes wrong, you will lose any investment that you have put into the home.
- Unforeseen Issues. Even with a contract, problems could still occur. If the house is foreclosed on or the owner takes out a lien on the property, you might end up inheriting those further down the road. These issues could possibly even nullify your deal entirely. And while you may have legal recourse if this happens, that could cost you a lot of time and money to sort out.
- No Guarantee of Financing. If you are unable to qualify for a home loan once the term of your lease has expired, you won’t be able to buy the home. If this ends up being the case, the landlord might make the decision to rent or sell to another buyer. Check to see if your contract contains a renewal stipulation and, if it does not, you need to make sure that your credit score and debt-to-income ratio are in the best shape possible before the term of the lease is up.
- Upkeep Costs. Although we mentioned that some contracts may contain a clause that dictates the sharing of the responsibility for repairs and maintenance, not all of them do. Some leases put the onus of that entirely on the shoulders of the renter. As we said, this could be preferred, as this will possibly be your home someday. But you should be aware of who is going to pay for this work before you sign your contract.
- Locked In Price. We likewise mentioned the purchase price of the home being set once the contract was signed as a pro above. But the locked-in price could be less than ideal if the local market goes down and you are stuck with a much higher sticker price than you would normally be paying to purchase a home in your area. And if the purchase price doesn’t meet the appraisal criteria of the lender, you will likely not get approved for your loan.
- One Late Payment Could Sink You. Unless it specifically says otherwise within the wording of your lease, a single late payment could give the seller the right to terminate. If they decide to do so, you would lose the entire investment that you have made up to that point.
#3: Understand Your Contract
As with any legal contract, you need to read and understand a lease agreement before you sign on that dotted line. Read through everything, including the fine print. Understand the obligations and any deadlines that you are going to be responsible for. Know what the settled buying price will be and how you can exercise your intent to purchase when that time comes. Examine what the option fee and rent payments are going to be and thoroughly read through clauses, including pet policies and other fees that you might have to pay.
Rent-to-own contracts are notoriously complex since there is no true standard for what they can and cannot contain. This means that there are a lot of people out there who take advantage of people looking to enter into such a contract. Beware of scams and the contract’s language. Research the seller’s credit and financial history if you can. Understand who you are entering into this agreement with. And do not provide any of your financial information up front.
While you are at it, check up on the history of the home. Hire a home inspector before you agree to or sign anything. This can help identify potential issues or problems that might lead to expensive fixes in the future. It will also protect you against any claims of property damage if you end up deciding not to purchase the place. The owner should be more than willing to pay for this inspection. And if they refuse to let you have one done, consider this a major red flag.
You might want to consider hiring a real estate agent or possibly even a real estate lawyer. These professionals could not only help you in navigating your way through this lease agreement, but they will have your best interests in mind above that of the owner. Similarly to what we said before if the landlord is unwilling to provide a fee-free copy of the contract for your attorney, walk away from the deal.
Bottom Line: Arm Yourself with Knowledge
Just as in so many other aspects of life, the more you know the better prepared you can be for what awaits you. Doing your homework and educating yourself on rent-to-own homes and their contracts can help you to avoid many of the potential pitfalls and will aid you in finding the most secure path forward that you can take. Armed with this list and the information contained within it, you can be confident that your path will one day lead to you owning your new home.