How Does Rent-to-Own Work?
You’ve just found the perfect home. It has an ideal layout and is in your dream neighborhood. Plus, it was listed by a rent-to-own company, so you don’t have to come up with a hefty down payment!
Instead of saving for a new home while you throw money at a rental, you realize you can move in this house right away. Even better, a portion of your monthly rent check will go toward your down payment or equity in the home. At the end of the contract, you’ll have the option of purchasing the home.
Sounds too good to be true, right?
While it may seem tempting, the rent-to-own process can be risky—especially for buyers. So, how does the rent-to-own process work? What are the real pros and cons?
Look no further because we’ve got the answers.
What Is a Rent-to-Own Home?
A rent-to-own home is a house you can buy through a rent-to-own agreement. With this type of contract, you agree to rent a property for a specific time period before gaining ownership. The time period can range from several months to several years, depending on the specifics of the contract.
Like any other home, companies or individual sellers can own rent-to-own (or lease-to-own) homes, but they work much differently than the typical home-buying process.
As part of the contract, the seller agrees to hold a designated amount of money of each rent payment to go toward the buyer’s equity in the home when they purchase it. And what if the buyer doesn’t end up buying the house? We’ll explain that later.
Let’s go back to that dream house of yours. If it’s available as a rent-to-own home, you would have to negotiate the terms with the company or individual seller who owns the property. And because everything from the purchase price to closing costs is negotiable with a rent-to-own home, the process can get a bit tricky.
There are two different types of rent-to-own agreements: a lease option agreement and a lease purchase agreement.
With a lease option agreement, you have the option of purchasing the home after the agreed-upon time period. However, if you go with a lease purchase agreement, you are legally obligated to buy the house.
How Does the Rent-to-Own Process Work?
There really isn’t a one-size-fits-all option when it comes to the rent-to-own process. However, most rent-to-own transactions involve these components:
Purchase price. The rent-to-own agreement will specify how and when the purchase price is decided. The price could be based on the home’s current value—or a predicted one. In some cases, the price becomes official when the buyer and seller sign the contract. In other situations, the purchase price won’t be decided until the lease expires.
Rent payments. As part of the contract, you’ll agree to pay a certain rent amount each month. These payments are typically higher than rent prices in the area because a percentage of each payment is set aside as a credit for your future purchase of the home.
Maintenance. In a rent-to-own agreement, the seller may ask you to cover costs such as repairs, maintenance, HOA fees and property taxes while you’re renting. You could be on the hook for everything from landscaping to a broken air-conditioning unit. That’s why it’s so important to walk through the contract with an attorney who can clearly explain what each party is responsible for.
Option money. You’re required to pay the seller a onetime, nonrefundable fee. This gives you the opportunity to buy the house, and in some cases, the seller will agree to put this amount toward the buyer’s equity in the home. There’s no standard option money amount; it’s typically a percentage of the home’s purchase price.
Lease term. You and the seller will agree to a specific lease term in the contract. If the lease ends and you either decide not to move forward with the purchase or you’re unable to qualify for financing, the option to purchase will expire.
Closing process. You’ll need to secure financing at the end of the lease term if you plan to purchase the house. At that point, the lender will set a closing date where you’ll be given ownership of the property as the buyer. Depending on the terms of the agreement, the percentage of rent money set aside for your purchase and/or option money will be credited to you.
Because the rent-to-own process is less regulated than a typical buying or rental process, there’s no standard rent-to-own contract. The terms are completely negotiable. If you’re entering into a rent-to-own process, you need to talk to a real estate agent and an attorney on the front end to make sure you understand—and are ok with— the terms of your unique contract.
What Are the Rent-to-Own Pros and Cons?
Sounds like nothing can go wrong here, right? Let’s be honest: It doesn’t take much for a rent-to-own agreement to go south—fast.
Even if it’s your dream house, do the pros really outweigh the cons? Let’s dig in.
Pros for Buyers
You build a down payment over time. Instead of having to fork over a significant down payment when you move in, you build equity over a specific period of time by paying higher rent.
You can avoid buyer competition. At the end of the rent-to-own agreement, you won’t be up against other buyers for the property.
You don’t have to qualify for a mortgage right away. You may be drawn to a rent-to-own program because you can’t afford to buy a home yet. Maybe you’re still paying off debt or you don’t have a down payment saved. Moving into a house without qualifying for a mortgage may seem like the answer, but here’s the truth: The chances of your rent-to-own agreement falling through go way up if you’re already in a financial mess.
Cons for Buyers
Your rent will be more expensive. Even if your contract is set up so that part of your rent is going toward equity in the home every month, your rent prices will be higher because of that. Why not just rent a place for less money and keep the money you’re setting aside for a down payment in your own bank account instead of your landlord’s?
You’ll pay nonrefundable option money. You will have to pay a percentage of the home’s price to have the option to purchase the home down the road. These are payments you probably won’t get back if the deal doesn’t work out.
You may have to pay for repairs and maintenance. In rent-to-own agreements, it’s not uncommon for you, as the potential buyer, to be responsible for all repairs and maintenance. Those unexpected emergencies can put a serious hole in your pocket—for a house that isn’t even yours yet!
Home values could go down. If you have a rent-to-own contract for a couple years, you have no way of knowing what the real estate market or local economy could do during that time. Sure, your home value could go up, but it could also drop. The purchase price you lock in at the start of the contract is usually inflated to account for rising home values. That means, you could end up paying more than the property is actually worth.
You could decide you don’t want to purchase the house. Let’s say you get a new job that requires you relocate to a new city. Or maybe you still can’t qualify for a mortgage at the end of the contract term. Perhaps you just decide this house isn’t for you. If you’re in a lease option agreement, you can walk away from the contract. But what happens to all of the cash you forked over in higher rent and option money? That’s thousands of dollars you won’t get back.
The contract favors the seller. Something as small as a late rent check or not paying for a repair in a "timely manner" could release the landlord from any obligation to honor the contract. There won’t be a knight in shining armor headed your way to save the day—or your contract.
Events out of your control could cause you to lose your equity. If the landlord’s financial situation changes and the house goes into foreclosure, that house goes to the bank—not to you. Or, if the seller just up and changes their mind after they’ve signed a rent-to-own contract, it would take expensive legal action to enforce the contract in that scenario. That’s a cost you may not be able (or willing) to pay.
When you have dreams of buying the perfect home for you and your family, it can be all too easy to rush the process. Just remember: Although a rent-to-own agreement is a legally binding document, it has way too many loopholes to be a guarantee. Keep your money in your own bank account and steer clear of rent-to-own contracts!
Alternatives to the Rent-to-Own Process
When it comes to rent-to-own homes, the cons outweigh the pros. If you want to make a smart decision for your future, it’s simple. Avoid a rent-to-own situation, even if it means you have to wait to move.
Trust us; it’s worth it to buy a house the smart way. If you need time to clean up your finances, that’s okay. There’s no shame in renting while you pay down debt and save an emergency fund. In fact, that’s the best thing you can do! After your finances are in order, you can start putting money aside for a hefty down payment. Don’t buy a house—or sign an agreement to buy a house—when you’re broke!
We’ll shoot straight with you: Cleaning up your financial mess and saving a down payment isn’t easy. It takes hard work and sacrifice. But it’s worth it! When you move into your new place, you’ll have peace of mind knowing you made a choice that will bless your family for years to come.
We get it. The pressure to buy a house is real. But before you jump into a rent-to-own situation that wrecks your future, let us help you understand your options and make the best decision for your future.
Buying a house the traditional way may take more time, but it’s worth it.
Article Source: www.daveramsey.com/blog/how-does-rent-to-own-work