Some things you don’t want to rent to own. Bowling shoes, for instance. But a home? Yes indeed, that’s a great option for many people.
A rent-to-own agreement is a solid option for people who long to live in an honest-to-goodness home, but who can’t get a mortgage or don’t have a lot of down payment money. Any legal agreement requires intense scrutiny and understanding, so read up on the basics of rent to own before going any further. It’s for your own good, promise.
What does rent to own mean?
The phrase “rent to own” is fairly straightforward.
Renters pay a set amount per month in rent. On top of that, the renter also pays a preset amount. These extra funds go into an escrow account for future use as a down payment on this particular home. This is also known as a rent credit or rent premium and is usually 20 percent above-market rent.
So, a person could pay $1,000 per month in rent, plus $250 per month for the eventual down payment. Think of it as forced saving, if you will. It’s also standard for the renter to put down 3 to 5 percent of the home’s value as a nonrefundable deposit before taking residence.
Rent-to-own agreements can vary in length but are usually one to three years.
Types of rent to own agreements
Don’t make the mistake of assuming that legal mumbo jumbo sounds the same, so it means the same. In fact, that’s a pretty financially perilous error. There are a number of different ways to structure a rent-to-own agreement. These are the two most common.
Option to buy agreement
This type of agreement lets the tenant choose whether or not to buy the home at the end of the agreed-upon period. The risk here is that if the renter chooses not to purchase the home they forfeit any accrued rent premiums, not to mention the option fee. Ouch. This is also known as a lease-option agreement. In order to proceed at the end of the agreement, the renter must obtain a mortgage. The owner cannot sell the home out from under the renter during the agreement. The renter can also opt not to buy the home at the end of the agreement. The purchase price is usually frozen at the beginning.
Also known as a lease-purchase agreement, there’s no wiggle room here. This type of contract means that you will buy the home once the lease expires. Hence, the word “obligation.” If you don’t buy the house, you’ll lose any premiums paid during the process. There might also be legal ramifications. Clearly, this is a much riskier option.
How to rent to own
So you want to rent to own. How do you go about it? Here are some solid options.
Find a real estate agent
It might be tempting to do the legwork yourself, but a great agent can save you tons of time and money. First, they have access to search resources and property networks that you don’t. Second, they work with sellers all the time and can spot crooks from a mile away. They are also adept at helping to negotiate a contract that’s reasonable to both the tenant and the seller.
Find a rent-to-own program
Companies have emerged in recent years that will actually buy the home you’re interested in, and agree to lease it to you for a period of time. After which you can choose whether or not to purchase. Renter and seller choose a purchase price at the beginning, which is a big boon for the renter if the market trends upward.
One of the most well-known such companies is Home Partners of America, which doesn’t even require the renter to build equity during the process. This is ideal in areas where rentals are scarce, such as good school districts.
Approach the landlord directly
Perhaps you’re already renting a home that you love. Ask the landlord if he’s interested in selling in the future. Who knows? He might be about ready to cash out. Or, keep an eye on the real estate listings. If a home hasn’t sold after a long time with no movement the owner could entertain other options.
Things to remember before you rent-to-own
Whether you use an agent or not, denote in the contract if the landlord or the tenant (you) is responsible for home maintenance, repairs, landscaping, homeowners association dues, property taxes and so on. Failure to do so could cause some nasty and expensive surprises.
Also, complete a thorough home inspection before you sign the contract. No one wants to rent to own a home with a major foundation or other pricey problem. While you’re at it, check out the seller’s disclosure to find out about any hidden past problems.
Lastly, make sure to discuss your situation with a future lender. You’ll need to be able to afford the home in one to three years. Are you on the right path? If not, what needs to change?
Pros and cons of rent-to-own
- Pro: A rent-to-own agreement with a rent credit forces the renter to put away money. Saving for the future is a good thing!
- Pro: Rent to owns are a good way to break into a desirable area.
- Pro: The purchase price is typically set at the beginning of the agreement, so this could be great if the market explodes.
- Pro: A contract leaves little doubt as to who’s on the hook for what.
- Con: If a renter chooses not to purchase the home they forfeit rent credit money (and any deposit).
- Con: Many rent-to-own homes are not located in such desirable areas, so it might take extra legwork and patience to find one.
- Con: The market could also tank, leaving you to weigh whether to pay more than the current value of the home or not.
- Con: Be sure to follow your contract to a “t,” so that you don’t wind up losing a deposit or get fined.
There’s no place like a rent-to-own home
The path to homeownership has changed tremendously just in the last decade or two. As long as you consult with trusted experts and weigh your individual situation carefully, selecting a rent-to-own home is a great route to take.
The information contained in this article is for educational purposes only and does not, and is not intended to, constitute legal or financial advice. Readers are encouraged to seek professional legal or financial advice as they may deem it necessary.