These days you may be hearing more about rent-to-own homes. Maybe you’ve heard that they’re a great option for those who want to buy a home, but either don’t have the down payment money saved, or need a better credit score.
But, how does rent-to-own really work?
Similarly to a car lease, renters pay an agreed price to rent a house, and at the end of the lease, the renter has the option to buy the house at a determined priced.
The key to this process is the having a very clear, signed contract, because these types of arrangements have the risk of becoming a legal battle.
In a rent-to-own home, not only do you have to negotiate the rent price, but also the sale price the buyer has to pay at the end of a determined period (usually one to five years). The risk is that locking in a sale price may affect either the buyer or seller negatively if the housing market changes. If home prices decline, then the buyer will be stuck with a higher home price. If the home market recovers and prices go up, then the seller is forced to sell the home at a loss.
Also, renters have to pay an option fee (approximately 1% of the sale price) at the beginning of the lease, and also a rent premium. The option fee becomes part of the down payment, if the renter buys the home. If no sale is made, then the owner keeps the option fee as extra income. The rent premiums are a set amount of money added to the monthly rent. A portion of rent premiums go toward the down payment and the rest is also extra income to the seller.
This type of living arrangement can be good for potential home buyers who don’t have enough money saved for a down payment or don’t have a high enough credit score to buy a house.
But, both the seller and the buyer incur risks when getting into a rent-to-own arrangement. For instance, if the buyers walk away from the deal, they lose the option fee and premium rent money they’ve paid. Also, if the rent is paid late, the owner may keep the premium amount for that month. If the owner doesn’t pay his mortgage and the home goes into foreclosure, the renter will be forced to move. Also, any maintenance and repair work may become the responsibility of the renter, even during the rental period.
There are also risks, or disadvantages, for the seller. For instance, if home prices are going up, the sellers could get locked-in to a low home price. Since the seller has a contract with the renter, if a new potential buyer wants to make a higher offer, the seller can’t accept it because there is a binding contract in place.
If you decide to enter into a rent-to-own contract, make sure you have a real estate attorney and real estate agent to guide you through the process.