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As of June 25, 2018, we’ve made some changes to the way our mortgage approvals work. You can read more about our Power Buyer ProcessTM.

Buying a home is relatively straightforward. You find a home, you make an offer to the seller, the seller accepts your offer, and the agreement is signed at closing. In this process, typically before you make an offer, you’ll get a preapproval letter from a mortgage lender approving you for a mortgage loan in order to buy the home. After closing, you agree to pay the lender monthly payments until your mortgage loan is paid off.

Most often, you’ll need a fairly good credit score and a down payment in order to qualify for a mortgage. So what do you do if you don’t have good credit or are struggling with a lot of debt?

An option to consider is a rent-to-own purchase. But before you jump feet first into a contract, it’s essential to know and understand the risks of renting to own.

What Is Rent-to-Own?

When you rent to own, you, as the buyer, enter into an agreement with the owner of a home to pay a monthly rent for a predetermined amount of time, much like any other rental agreement. However, in this case, a portion of your monthly payments will go toward reducing the sales price of the house. After that time is up – usually from one to five years – you’ll have an option to purchase the home.

How Rent-to-Own Works

The rent-to-own process is a bit complex. It’s not as simple as paying rent and then buying a home. First, you and the homeowner sign a contract stating how much the final sales price of the home will be after the rental period ends.

The contract will also indicate how long you’ll rent the home before you have to decide whether to buy it and how much you’ll pay in rent each month. The contract should state, too, how much of your monthly rental payment will go toward reducing the final sales price of the home. It should also list what happens to any extra rent money you pay each month. In most rent-to-own agreements, that extra money is also nonrefundable.

After signing the contract, you’ll pay the homeowner an option premium. This premium gives you the right to buy the home after the rental period ends. Option premiums can vary, but they usually total around 5% of the home’s agreed-upon final sales price. It’s a bit like putting a down payment on a home.

The option premium is nonrefundable but can be applied to the home’s final purchase price. This may help when you decide to buy the home, because you won’t have to come up with as much cash at closing.

An important thing to consider that many buyers forget to include in their contracts is home maintenance responsibilities. Your agreement should state who is responsible for routine maintenance and extensive repairs. Local laws may complicate things, because in some areas, landlords are required to perform certain duties regardless of what your agreement states.

Benefits of Rent-to-Own

A rent-to-own agreement gives people who would otherwise struggle to qualify for a mortgage loan the chance to hold onto a home while they rebuild their credit, boost their income or take other steps to make themselves more attractive to mortgage lenders. The hope is that after the rental period ends, they’ll be able to qualify for the mortgage loan they’ll need to buy the home.

If you’re struggling with bad credit or are waiting for negative factors on your credit report to fade, a rent-to-own agreement may give you the time to work on rebuilding your scores. That way, once it’s finally time to buy the house, you’ll be in a better position to qualify for a mortgage.

Another benefit allows buyers to lock in a purchase price, which can be especially beneficial in a time when home prices are on the rise. If the option money or a percentage of the rent is applied to the home’s purchase price, you can also begin to build equity.

Risks of Rent-to-Own

Is a rent-to-own transaction the right move for you? It could be, but renting to own does come with its share of pitfalls. Plenty can go wrong with these transactions. It’s up to you to determine if the risks are worth the possible reward of becoming a homeowner.

If you decide not to buy the home in the future, you’ll be out of that upfront option premium payment with no home to show for it. You’ll also be out all of the extra rental money you paid each month that was supposed to go toward reducing the home’s purchase price.

And even if you do want to buy the home after the rental period, you won’t be able to if you haven’t managed to fix whatever financial problems prevented you from qualifying for a mortgage loan in the first place.

Another potential pitfall is your lack of control. Because you don’t yet own the property, you have no say in what happens to the home. Your landlord could be pocketing the rent money and not paying the mortgage, eventually losing the property to foreclosure.

You can also lose out if the home loses value during the rental period. Once you agree on a sales price with the seller, you won’t be able to change it. If you agreed to pay $200,000 for the home when you signed the contract, you’ll have to pay that same amount even if the home is now worth only $170,000.

Of course, if the home rises in value during the rental period, you’ll gain. You can buy that home for less than what you otherwise would have had to pay for it.

In some cases, if you have a late rent payment, you could lose the right to purchase your home or that extra payment for the month does not count toward the final purchase price. In other words, make sure you read the fine print in your contract and look for clauses like this.

Sometimes, there are issues with the home that you might not be aware of until you go to buy the home. The seller may have issues with the title or may not own the title, or there may be major issues that a home appraiser will not approve in order for you to buy the home. The best advice for this is to treat your rent-to-own agreement like an actual home purchase, so get an inspection and do a title search before signing anything.

Remember, before you assume that you won’t qualify for a mortgage, make sure you do your research first. We have many options to fit many different financial situations. You may actually be in a position to qualify for a mortgage and not realize it, so talk to a Home Loan Expert today.

If you have a rent-to-own experience you’d like to share, please tell us in the comments below.

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This Post Has 8 Comments

  1. It is better to keep your home rather than selling it. Many people believe that it is better to sellanyhome rather than keeping it for a long term investment. A rent is not cost effective and you’ll end up spending a lot of money on rent. Selling a home is something I wouldn’t recommend.

  2. What happens if the current landlord/property owner dies before the transaction is completed? Or property becomes part of a legal proceeding such as divorce or civil judgement?

    1. Hi Shel:

      Unfortunately, this is one of the risks you take with rent-to-own homes. You don’t own them until the contract is complete and you have a final sale. If the property becomes involved in any legal proceeding, you may well be out of luck.

      Thanks,
      Kevin Graham

  3. I work in the industry and I am trying to get my credit up, however I see people with worse credit get into homes and lenders will not look at me. Why is that? Yes my credit needs to improve but it is going up.

    1. Hi Nancy:

      Your credit isn’t the only thing that goes into your mortgage approval. You also really have to consider your debt-to-income (DTI) ratio. Here are some of the factors to think about. If you want to go over your options and get some advice, you can certainly talk to one of our Home Loan Experts by filling out this form or calling (888) 980-6716.

      Thanks,
      Kevin Graham

  4. I have (3) rent to own homes and all 3 have people in them. Yes, they put money down to own a home, but its far less than the 10-20% mandated by the mortgage loan industry. Most are 3% down. So ask the Realtors the last time they were able to get a client into a home with only 3% down.

    Realtors are only concerned with their payout. They want their 2-3% on a deal. So look at that $200,000 deal again, they ware looking for their $5000-$6000 payout, a rent-to-own or Lease with the Option to buy, cuts them out of the deal. Sure they make for GREAT sound bites when discussing this solution.

    I have seen many people find a home with a Realtor, get to the 11th hour and then be told by the mortgage people that there is a “blip” on the credit that will not allow them to close. Never happens with Rent To Own, since I am the bank and property owner, their cash allows them to live as if they are buying and over time, the credit improves as they pay me to live in the house. Sure my interest rate is 7% versus another bank, but I have more risk with this person, as their credit is not as good.

    My deals involve monthly payments that are far less than rents in the area, and they include the taxes, insurance and principle. These people own the house, make improvements, and I also give them money off the purchase price with credits toward improvements. Most get $3000-5000 off based on painting, yard improvements, and other enhancements. When did a bank give this, or worse, a Realtor?

    Is Rent to own or Lease Option for everyone? No, some won’t pay the higher interest rate, they’d rather have a landlord fix stuff and never have equity, content to pay stuff in cash and never need a mortgage, but others see value in the house and with banks being in charge of credit, they don’t care about blips or blemishes. These are good deals for people who cannot qualify with a bank.

    Jack

    1. Hi Jack:

      I understand and respect your point of view, but I wanted to offer a counterpoint.

      Regarding down payments, there are a couple of programs through Fannie Mae and Freddie Mac that offer down payments as low as 3%. Quicken Loans offers a 1% down payment option for well-qualified buyers. FHA’s minimum down payment is 3.5%. You may have to pay for mortgage insurance, but the idea that you have to put 10%-20% down is a myth.

      As far as credit, we do have to make sure buyers are well-qualified for loans we put them in, but if you get a lender that does their homework with the preapproval – pulling credit, income and assets ahead of time – it’s unlikely that at the last minute a surprise will sink the deal.

      Thanks,
      Kevin Graham

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