If you’re in the market for a new home but can’t afford a down payment, or can’t get approved for a mortgage, you may want to consider a rent-to-own option. By that same token, home owners looking to sell but who are having trouble finding a buyer or are worried about falling market prices could consider this option as well. Although a rent-to-own home purchase may not be the best choice for everyone, it can be a good solution for buyers and sellers alike – especially in a housing market downturn. Before entering into any such agreement, it’s important to understand what a rent-to-own home purchase really is.
Essentially, a rent-to-own home purchase agreement is a two-part contract. The first part is where the seller agrees to rent or lease the property to an interested buyer for a set amount of time. Typically, this time period is 1-3 years. During this time period, a portion of the monthly rent goes toward a down payment for the home. Also during this time period, the home owner will usually charge what is called an option fee in exchange for not listing the home on the market. In some cases, this fee can be applied toward the home purchase.
At the end of the stated time period, the lease ends and the second part of the contract comes in. If the tenant is still interested in purchasing the home, he or she can do so; however, the tenant is never at any time obligated to purchase the home. If the tenant chooses not to purchase the home, he or she will lose the option fee and the home owner can either put the home back up on the market to sell to someone else or they can restructure or renew the lease contract.
Pros and Cons
There are different scenarios in which the seller and renter could experience benefits or drawbacks with this type of contract. As a seller, a rent-to-own plan can make it easier to initiate a sale sooner. Another advantage to sellers is that it allows them to “lock in” a set price for their home. This can be beneficial if the local market in in a downturn and prices are dropping.
As for disadvantages, sellers should be aware that there are no guarantees in this kind of agreement. At the end of the tenant’s lease portion, there’s no obligation for them to buy. Therefore, even if you’ve determined a price of $200,000 in the contract, by the time the renters leave, the house may bring in significantly less. Also, as a seller in this arrangement, you restrict the amount of marketability for your home. During the lease period, the home won’t be visible in listings so you are betting on your renters to buy once the lease is up.
There are just as many pros and cons for the renters in this type of agreement. As potential home buyers, the renters may need a little more time to improve their credit or they might need a few years to save up for a down payment. A rent-to-own home purchase agreement can help, as it provides more time for the lessees to acquire a mortgage.
Some people prefer to save up for a down payment on their own, but if you’ve found a home you love and the seller is willing to do a rent-to-own plan, it might be your best option, since the seller will automatically take a portion of your monthly rent and put it toward your down payment. This would also be helpful to people who find it hard to put money aside every month. With this kind of agreement, it’s taken care of for you – as long as you make your rent payments.
As the lessee in a rent-to-own agreement, you are also able to “try on” a home before entering into a bigger financial commitment.
The downsides to a rent-to-own home purchase for lessees are similar to those for anyone who rents a home. While in the lease period, it is still technically the owner’s property. Renters would still have to ask permission from the owner before doing any remodeling or modification to the home.
Lessees will also most likely be paying a bit more than the average rent for similar properties. This is because the home owner will probably charge what’s called a rent increment. This is how the owner makes up for the money that’s going toward the down payment each month. The rent increments on rent-to-own homes can be as much as an additional $200-$300. Mortgage rates may also change during the rental period, which could end up making the home more or less affordable by the time of purchase depending on whether they go up or down.
One of the biggest drawbacks for lessees in a rent-to-own agreement is if they decide not to buy at the end of the rental period. If they choose not to purchase the home, whether it’s because their credit still isn’t good enough or they just changed your mind, they will lose the option fee as well as the rest of the money that had been going toward the down payment. On a $500,000 home, the option fee alone could come to as much as $10,000.
After learning more about rent-to-own home purchases, you may find it’s the perfect solution for you. Or, you may feel it’s not worth the risk. Just remember to think carefully and weigh all possible outcomes before making a decision.