Do you want to own a home, but not yet? Are you afraid of buying into a real estate market that could suddenly crash? You are not the only one. Real estate is a very serious purchase and will probably be your largest purchase. One of the solutions provided is the rent to own model. It may not be the best solution though. There is much confusion, sometimes even legal confusion to what a rent to own home is.
A rent to own home is a real estate agreement between a tenant and a landlord with the potential to change into an agreement between a buyer and seller. The basic concept is that the prospective tenant/buyer will pay a set amount upfront followed by regular payments much like any lease. After the lease is completed (usually 1 to 5 years) the tenant can buy the property from the owner and have the right of first refusal. The right of first refusal states that the tenant must be the first allowed to purchase or refuse the property.
In this post I will address what a rent to own home is and help you learn what to look for in a rent to own so you can make an informed decision.
The Detailed Structure Of A Rent To Own Agreement
A rent to own agreement is a fairly complex contract where the details matter. Rent to own agreements fit in two categories. There is the lease option and the lease purchase.
Qualities Of A Lease Purchase
The lease purchase is an agreement that you will buy the house after a certain amount of time of leasing.
Do not agree to these! They are essentially delayed purchases where you agree to pay rent for a few years then to purchase the home at a set price that is all but certain to change in value. Many tenants have regretted signing these contracts.
Qualities Of A Lease Option
The lease option is essentially a trial run to home ownership. The agreement starts with a fee called the options fee where the tenant puts down typically 1-5% of the home’s value. It is like a mini down payment for a home (or in some cases, the down payment). This fee goes to the purchase of the home after the lease agreement. The agreement includes a set amount of time to lease the home, usually 1-5 years. The rent during this time may or may not include a certain amount that goes towards the payment for the home called a rent credit.
After the lease is over, the tenant can purchase the home from the owner. They need to find financing and provide an additional down payment. For instance, let’s say you pay 5% from the options fee and a total from the rent credits that contributes to an additional 5% of the home value, you need to pay an additional 10% for a 20% down payment.
The tenant can back out of the contract hence the term “option.” However, the tenant is not likely to get their option fee back, that is normally non-refundable.
Pros Of Rent To Own Homes
Rent to own homes can be beneficial to potential homeowners. They could be tools used to find the best deals out in real estate.
Try Out Properties In Certain Markets
Rent to own homes allow you to try properties in markets you are not sure about. Sometimes there is a property you may be interested in, but are not sure how certain events will transpire in the future.
For instance, let’s say you want to try out a rent to own home. However, you know the neighbors are first time homeowners who may have borrowed too much, therefore they could leave if the economy turns sour. If this happens your house value could lower significantly.
Rent to own homes could be an excellent way for potential homeowners to try out homes in emerging real estate markets. It is impossible to predict exactly what will happen in certain markets. Rent to own could allow you to try property without any long term commitment to sign like a mortgage.
Fix A Price For A Home
When signing a rent to own agreement, a price for the house needs to be agreed upon. If the market is appreciating you could sign up for a price that is lower than you would when you are ready to buy a house a year or more down the road.
Home appreciation has stuck around 3-5% in many metro areas in the US according to Zillow. You could have a house that is 3-16% depending on the rate of appreciation and whether the lease is 1-3 years.
More Accessible Down Payments
Many mortgages could require a 20% down payment. With the tightening of credit it appears that requiring a 20% down payment is a new reality. JPMorgan is already requiring a credit score of 700 and a 20% down payment for mortgages.
It is easier to ask for a loan if you already have some money in your down payment from the option fee and whatever can be added from the rent. Even if you only put 5% down at the end of your loan with the median house price of $320,000 that is $16,000 down, you would need to save an additional $48,000 over your lease to cover a 20% down payment. You will likely cover even more after your lease with a rent to own due to rental credits.
Even if the amount you put down from the rent to own is relatively small it can be a great way to make your down payment.
Access To Homes With Sub Ideal Credit
Normally, you need fairly good credit to buy a house, even before 2020. However, you only need a more moderate credit score to rent, you could even go as low as a credit score of 600 in many cases. Rent to own can put you on the path to home ownership with less than good credit scores.
Note: there is no guarantee that you will obtain a mortgage without at least improving your credit score. You should take the time during your lease term to improve your credit score.
Cons Of Rent To Own Homes
Unfortunately, rent to own agreements are not for everyone. In fact, it could be risky.
The FTC issued a warning that rent to own homes could be scams. Unfortunately, rent to lease agreements are not always regulated by any government. The contract is established almost exclusively from negotiations. Many tenants have ended up with terrible deals. Some have even been scams.
There are numerous ways that these could be scams
- Fake sellers
- Owners did not pay property taxes
- Property is in unlivable conditions
- Property is being foreclosed on
Since the government does not directly regulate rent to own agreements these types of scams can and do happen. If any of these happen technically you are not even signing a viable rent to own agreement.
You May Need To Pay For Maintenance
One of the greatest cons of rent to own agreements is that most of the time you will have to pay for maintenance and most likely repairs that come up after the signing of the lease agreement. It makes sense. A rent to own home is a home you plan to own and you will live in it. If you did not need to pay for maintenance nor repairs you could leave the home is disarray and turn away from the agreement.
Unfortunately, this attribute of rent to own agreements is a true deterrent. What is the point of renting a home if you need to pay for repairs? Not saying the home is not good, but if you are agreeing to pay for all repairs you might as well own it.
Rent Is Likely To Be Higher
Most renters rent because renting is less costly in the immediate term. However, rent to own homes frequently use rent credits which goes towards the down payment of the house. This will make a monthly rent to own house’s rent more expensive than typical rent. In fact, in many situations the rent credit could make the monthly payment for a rent to own home more expensive than the monthly payment of a mortgage even with insurance and property taxes.
The Price Will Be Fixed
I know I just said the fixing of a home price was a pro before, but it is also a con. Housing markets generally go up. Cash, bonds, stocks, and even arguably cryptocurrency has a general upwards trend. That does not mean that the price will not decline at least once or a few thousand times.
Housing markets can and do crash meaning that you could lock in the price of a rent to own home that is now worth half the price. Luckily these situations are less impacting to your finances than owning the home. You may have put down an option payment and rent credits, but unless you still go through the agreement those are lost.
Rent to owns are still worse than renting. If you are a traditional renter and the housing market crashes, that’s too bad for your landlord. But otherwise, you will be fine.
You Cannot Mess Up, Not Even Once
If you are late on rent, your landlord could charge late fees, but otherwise you do have some room to negotiate and ensure that you are not evicted. If you are late on a mortgage, your could ask for forbearance and try to negotiate with your lender.
But what if you are late on the monthly payment for a rent to own home? The government does not regulate rent to own agreements meaning that they will offer little, if any, protection if you do not fulfill the terms of your contract to even the tiniest detail nor will offer much help nor assistance.
If you are late on your payment for a rent to own home, that’s it. The landlord/seller can and probably will back down from the deal completely meaning your options fee, rent credits, and repair expenses meant nothing.
What You Should Look For In A Rent To Own Home
Generally, I am against the idea of rent to own homes. The concept of rent to own is you will put down money straight forward and pay a large amount to the owner every month to stay in a place that is still technically their own. In the meantime you need to worry about repairs and maintenance without the promise of any safety net.
Rent To Own Is Not A Very Good Agreement
Essentially rent to own homes are agreements where you need to reach half way to the owners of the home and they will hardly reach back. You do not own the home, you cannot change the home to your liking, you cannot tap into the equity at all, and you may even face legal consequences if you back out of the agreement.
Rent to own may provide some unique benefits to help you reach home ownership, but it also comes with unique downsides. Note: this is advice from someone who generally has his finances together, a good paying job, and a credit score that could not only get me a mortgage, but a lower interest rate. It is a blessing to have those during the best of times much less the worst. Rent to own could be your only want to own a home anytime in the near future under your circumstances. I understand that.
No Mistakes Allowed
However, if you are seriously considering signing a rent to own agreement I must emphasize that you cannot make any mistakes. You cannot agree to a house that you cannot upkeep much less pay for fully.
If the house is in disarray and you must pay for that disarray you probably lost money that could have been saved with a traditional mortgage. If the owners are scammers you just lost a significant amount of money. And if you miss even one payment, you just lost everything you tried to build up.
An agreement should always provide a benefit to both parties. However, rent to own agreements tend to provide the tenant/potential buyer with very few benefits to the buyer versus that of the seller.
That does not mean a rent to own agreement would not benefit you, you just need to make sure it aligns in your favor as much as possible.
Have The House Inspected
A rent to own home is not like a traditional rental, you must have it inspected thoroughly like a home you want to own.
If there are any significant damages that you find, the house will be significantly lower in value.
If your landlord/seller wants to make a rent to own deal with a house that is in major need or repairs this is a red flag. That indicates that they are generally unwilling or unable to make those repairs and want to hand those repairs off to someone else. For instance, let’s say the walls need replaced. As a traditional tenant, you could always ask for repairs from the owner. As a traditional buyer, you can easily negotiate a lower price due to repairs. With rent to own, usually the owner does not do repairs nor can you easily negotiate a lower price much less rent.
It is best to stay away from rent to own houses in need of serious repairs.
If the rent to own house has any issue that makes the residence unlivable such as asbestos or radiation (it happens) that is a crimson flag. Stay away from those.
Do Your Due Diligence
The government does not really regulate rent to own agreements therefore the other party could easily take advantage. They may not own the house, never have paid for taxes or kept the house up to code, the home could even be foreclosed upon. You need to make sure that you are signing an agreement with a legit and responsible homeowner.
You need to have a lawyer present when you sign a rent to own agreement. As if the details of your rent to own agreement were not important enough they should do what they can to make sure the agreement is legal.
Rent to own agreements are very difficult agreements. You could use them to gain access to home-ownership, but the owners of the home could easily take advantage of the agreement and even a small mess up can negate everything you have been trying to do.
However, these are some of the only options to try to own a home. However, there at least used to be the capability to buy a home with 5% with some private mortgage insurance (PMI). Even with PMI, owning a home this way could be better than a rent to own agreement.
Furthermore, there are other ways to help build enough money for a house. These include down payment assistant programs, FHA loans, and many other government and private programs to help people buy homes without having to resort to either rent to own agreements, nor PMI, especially for first time homebuyers.