What to look out for, what to do, and the choices you have to make
If you’re like most people who buy a house, you’ll need a debt to pay for it. You need to have good credit and cash for a down payment in order to get the loan. Without these, the usual way to become a landlord might not be possible.
You can, however, sign a rent-to-own agreement and rent a house for a certain amount of time. You then have the choice to buy the house before the lease ends. There are usually two parts to a rent-to-own deal: a normal lease agreement and an option to buy.
What to look out for and how the rent-to-own process works are spelled out below. It is trickier than borrowing, and you will need to take extra care to protect your interests. For people who want to buy a house, this will help you decide if the deal is a good one.
What Are Homes That You Can Rent and Own?
Rent-to-own homes have a clause in the rental deal that either lets you buy the home or forces you to buy it after a certain amount of time. When you pay your rent every month, some of that money can go toward your down payment. If you decide to buy, you can use the extra money to pay for the house.
Renting to own can be a good option for people who want to own a home but haven’t been able to buy one using the traditional method. If you don’t have enough money for a down payment or your credit score is too low to get a mortgage, renting a house with the goal of buying it can give you time to save money and improve your credit score.
Upfront fees that can’t be returned
You, as the buyer, pay the seller an option fee, option money, or option consideration up front. This is usually a one-time fee that you can’t get back. You can buy the house at some point in the future if you pay this fee. There is no set rate for the option fee, so it is often possible to negotiate it. Still, the fee is usually between 1% and 5% of the price of the item.
Lease Purchase vs. Lease Option
It is important to know that there are various kinds of rent-to-own contracts, some of which are easier for customers to understand and adapt to than others. You can buy the house when the lease is up, but you don’t have to with a lease-option deal. At the end of the lease, if you don’t want to buy the property, the choice to do so just ends, and you can leave without having to pay rent or buy. This doesn’t always happen with lease-to-own deals.
For you to be able to buy something without having to, the deal must be a lease-option contract.1 Because legalese can be hard to understand, you should always talk to an experienced real estate lawyer about the contract before you sign it. That way, you’ll know your rights and what you’re agreeing to.
If you sign a lease-purchase agreement, you might have to buy the house at the end of the lease, even if you can’t afford to.
How to Get a Rent-to-Own House
This custom drawing shows how to buy a rent-to-own home. There are four big square column steps that lead up to a house in the sky. Set a price in a deal with the seller, says the text. Carefully read the lease-option or lease-purchase deal before you sign it. By paying rent every month, you can get a credit that you can use to buy something later. If you want to buy something, you should get a debt.
Zoe Hansen for Investopedia
When you sign a rent-to-own deal, you’re usually signing a legal document. The contract should spell out the terms of the deal and make it clear if you have to buy the house or just have the choice to. In general, a rent-to-own deal should have a few key pieces of information in it.
Choosing the Purchase Price: Rent-to-own contracts should say when and how the home’s purchase price is chosen. You and the seller may agree on a price to buy the item when the contract is signed. This price is usually higher than the item’s current market value. Under other circumstances, the price is set by the property’s market value at the end of the lease. A lot of people like to “lock in” the price of the home they want to buy, especially in areas where home prices are going up.
Putting rent on the principal
During the lease time, you’ll have to pay rent. The question is whether a certain amount of each payment goes toward the total price of the buy. Let’s say you pay $1,200 a month in rent for three years and 25% of that goes toward the purchase. You’ll get a $10,800 rent credit ($1,200 x 0.25 = $300; $300 x 36 months = $10,800). You usually have to pay a little more than the going rate for the area in order to cover the rent credit. You should know what you’re getting for that extra money, though.
In some contracts, you can use all or part of the choice money you have to pay toward the final price you pay at closing.
Maintenance for Rent-to-Own Homes
It depends on the deal, but you might have to take care of the property and pay for repairs. Usually, the owner is in charge of this, so make sure you read the small print of your lease carefully. Since the buyers are still in charge of the homeowner association fees, taxes, and insurance (it’s still their house), they usually choose to pay for these things. Any way you look at it, you’ll need renter’s insurance to protect your belongings and protect you legally if someone gets hurt in your home or if you hurt someone by accident.3
Make sure that the contract makes it clear what repairs and upkeep are needed (ask your lawyer to explain your duties). Maintaining the property, like cutting the grass, raking the leaves, cleaning out the drains, etc., is not the same thing as fixing a leaky roof or making sure the electrical wiring is up to code. Before you sign anything, make sure the property taxes are paid and that the house is inspected and appraised. This is true whether you’ll be in charge of everything or just the lawn.
Getting the House
What happens at the end of the contract rests on the type of deal you made. If you have a lease-option agreement and want to buy the house, you’ll probably need to get a mortgage or some other kind of loan to pay the seller in full.
You have to move out of the house just like you would if you were renting any other property if you decide not to buy the house or can’t get credit by the end of the lease term. It’s likely that you’ll lose all the money you’ve paid up to that point, like the choice money and any rent credit you’ve earned, but you won’t have to keep renting or buy the house.
If you have a lease-purchase agreement, you might have to formally buy the property when the lease is up. There are many reasons why this could be a problem, especially if you can’t get a mortgage. Most of the time, lease-option contracts are better than lease-purchase contracts because they give you more freedom and don’t put you at risk of being sued if you don’t want to or can’t buy the house when the lease is up.
Do your homework, learn about the area, compare prices of nearby homes, read the contract, and look into the seller’s past. Treat the process the same way you would if you were buying a house outright.
As part of the coronavirus stimulus package, the federal government, states, municipalities, and private lenders offer programs for renters and homeowners that help stop foreclosure and eviction and lower mortgage payments. These programs can help people who are having trouble with their finances because of COVID-19.
Who Should Rent-to-Own Homes Be Used For?
If you want to own a home but aren’t quite ready financially, a rent-to-own agreement may be a great choice for you. You can get your finances in order, boost your credit score, and save money for a down payment while “locking in” the house you want to buy. When you buy a house, you often get some money from the option price and/or a portion of the rent put toward the down payment. This lets you build equity.
People who can’t get conforming loans have usually been the target of rent-to-own deals. However, the rent-to-own business hasn’t paid much attention to a second group of potential customers: those who can’t get mortgages in expensive non-conforming loan markets. According to Marjorie Scholtz, founder and CEO of San Francisco-based start-up Verbhouse, there is a big need for a better way for financially stable, creditworthy people who can’t get or don’t want a mortgage yet to get a loan in high-cost urban real estate markets where jumbo (nonconforming) loans are the norm.
It’s no longer the consumers who are at fault when home prices go up and more and more places are priced out of conforming loan limits, forcing people into jumbo loans, says Scholtz. People who are financially stable may have trouble getting loans in these areas because of the strict automatic underwriting rules and 20% to 40% down payment requirements.
“Good income earners become “outliers” because underwriters can’t put them neatly into a box when something unusual happens, like when their income changes,” says Scholtz. People who don’t have a U.S. credit history (for example, foreign nationals) or who don’t have a traditional source of income, like self-employed or contract workers, or who don’t have a U.S. credit history at all are included. So are people who don’t have the huge 20% to 40% down payment that banks ask for nonconforming loans.
It’s not common to find rent-to-own homes in high-cost areas, which is what makes Verbhouse stand out. But all people who want to buy a rent-to-own home would be better off if the terms for these loans were more focused on the needs of the buyers: The option fee and a piece of each rent payment bring down the purchase price by the same amount. The rent and purchase price are fixed for up to five years, and participants can build equity and benefit from market growth even if they don’t buy. The participants can “cash out” at the home’s fair market value, according to Scholtz. Verbhouse sells the home, and the member keeps the market appreciation plus any equity they’ve built up through rent “buy-down” payments.
Before you sign the deal
When you sign a rent-to-own deal, you and the seller of the property may have to follow certain legal rules. Before you sign, here are some more things to think about.
Pick the Right Words
It is important to read the small print of a rent-to-own deal to know if it is a lease-option or lease-purchase deal. If you sign a lease-purchase deal, you might be forced to buy the house, which could be a problem if you later decide you can’t afford it or don’t want to own it.
You can better understand your rights and responsibilities in a rent-to-own deal if you have a good real estate lawyer read the contract to you. You might want to talk about some things before signing, or you could just walk away from the deal if it doesn’t work out for you.
Read the Contract: Rent-to-own agreements can be hard to understand, so it’s important that you know all the little details. Like, take some time to go over:
- The due dates (when things need to be done)
- What is the option fee and how much of each does go toward the buy price?
- How the price of the item is set
- How to use your choice to buy (for example, the seller may want you to write them ahead of time to let them know you want to buy).
- Whether pets are okay
- Who pays for repairs, homeowner’s club fees, property taxes, and other things like that?
- This is what “maintenance” means: Repairs that need to be done right away, like fixing a roof or just mowing the lawn and raking, etc.
- Look into the Home
- Prior to getting any home, even rent-to-own homes, it’s important to do some research. It can help you decide if you want to buy the house by getting an independent estimate, a property inspection, making sure the property taxes are paid up to date, and checking to see if there are any liens on the property.
Look into the Seller
If you work with the right seller, rent-to-own can be a good experience. Before making a decision, it’s a good idea to learn about the property owner’s background. You might want to look at the seller’s credit report for signs of financial trouble and get a title report to find out how long they’ve owned the property. The longer they’ve owned it and the more wealth they have, the better.
What Should You Ask?
It’s better to ask questions sooner rather than later if there’s anything you don’t understand about a rent-to-own deal. To give you an example, it’s helpful to know what would cause you to lose your right to buy the land. In some arrangements, you lose this right if you miss even one rent payment or don’t give the seller written notice that you want to buy.
If you buy a house, how is rent-to-own different?
Rent-to-own is a kind of hybrid way to buy a home, where all or part of the rent payment goes toward building wealth in the home over time. A homeowner will often let a renter build wealth in their home without them having to make a down payment or get a mortgage.
Why are rent-to-own agreements a good idea?
People who rent to own homes can start building wealth in a home they like without having to get a mortgage or make a big down payment. Some people may not be able to make a down payment because they don’t have enough cash or their credit score is too low to qualify for a mortgage.
When you rent to own, what should you think about?
Rent-to-own agreements can be very different, and the renter needs to do their research. It’s important to learn about the contract (maybe with the help of a real estate lawyer), the house (with an inspection and assessment), and the seller.
People who want to buy a house can sign a rent-to-own deal and move in right away. They have a few years to work on their credit scores and/or save for a down payment before they can try to get a mortgage. In order to follow the terms and conditions of the rent-to-own deal, certain things must be done. Before you sign anything, you should talk to an experienced real estate attorney, even if a real estate agent helps with the process. They can explain the contract and your rights. If you decide you want to buy instead of renting, you might find it helpful to look at the best mortgage rates to get a great deal on a loan.