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When my husband was transferred to San Diego in the early 1980s, we knew someone selling a house and entered into a two-year, rent-to-own agreement.

In a rent-to-own, the owner promises to sell the property to the tenant within a certain time frame and price. Typically, a portion of the rent paid each month goes toward the purchase price or the buyer’s closing costs.

These deals are more common in slow real estate markets when it’s difficult for homeowners to sell outright. They lose appeal in seller’s markets, because they involve increased risk – the tenant may not qualify at the end of the lease period for a mortgage, or may trash the property and leave.

In our case, though, everything worked out. We loved the house and neighborhood and closed right on time.

Benefits

Renting-to-own allows tenants to “test drive” a house and neighborhood while accumulating their down payment.

The agreement stipulates how much of the monthly rent will become rent credits – to be applied to the purchase price. If the home price is $200,000, the landlord may agree to apply 30% of the $1,500 monthly rent as rent credit. At the end of a two-year lease, the rent credit in this case would lower the purchase price of the home to $189,800.

The tenant builds equity in the home each month, although they will be paying fairly high rent. Renting-to-own also benefits the seller since any potential capital gains taxes are mostly deferred if the property is an investment property.

How Rent-to-Own Works

The agreement spells out who’s responsible for what, the lease term, and other variables, so read it carefully and consider asking a real estate attorney to review it, too.

You’ll also want to talk with a lender before entering into the agreement to find out what you’ll need to qualify for the loan down the road and get an appraisal and inspection. For you to get a mortgage on the home, the lender will have to agree that the base rent was the fair market value and that the option fee you’re paying was actually extra. This is important because if the lender believes the fair market value was higher, then you won’t be able to use that “extra” money for the down payment.

The fair market rent will be determined for the lender by an independent appraiser.

What’s an Option Fee?

Some rent-to-own agreements include an option to purchase, which means you’ll pay an “option fee,” usually 2 – 7% of the purchase price, for the right to purchase the property at a later date.

If the tenant exercises that option, the seller must sell the property to the tenant and apply the option fee to the purchase price. If the tenant chooses not to exercise that option, they’ll forfeit the option money.

Lease Purchase

Other rent-to-own contracts include an agreement to purchase. This means both parties have agreed on a purchase price, or that the purchase price will be determined with a future appraisal.

This is the type of agreement we had in San Diego, which was fortunate because the housing market there was cool at the time and the home we were renting appraised for less. We met with the owner and agreed on a new price.

Which option you choose depends on the market where you are renting. In a rising market, a fixed price will allow you to have equity in the home even before making the purchase. In all other market conditions, an appraisal at the time of purchase will ensure you don’t pay more than market value.

Who Pays for Repairs?

The rent-to-own agreement should cover who is responsible for maintenance and repairs.

Often the tenant will pay for small repairs and regular upkeep while large repairs like a leaking roof or structural damage are the landlord’s responsibility.

Other Caveats

 Under most rent-to-own agreements, you will lose your monthly rent credit if you pay the rent late – even by a single day. And even if you’re current with your payments, if the landlord doesn’t pay the mortgage, property taxes and insurance payments on the home, it could turn into a foreclosure and you might be evicted.

What Sellers Should Know

As a homeowner, you have a lot of money invested in your property and you’ll want tenants who will take good care of your home. You should find out all you can about your prospective tenants and review their credit report.

Under the contract, you should have the right to collect a deposit and first and last month’s rent, and the right to evict your tenant if the rent is not paid.

What Tenants Should Know 

If you’re considering a rent-to-own agreement, be sure your credit score will be high enough to qualify for a mortgage by the time the lease expires.

If you cannot qualify for a home loan once your lease-to-own agreement is up, you’ll forfeit all of your equity.

What Happens at Lease-End?

 The tenant can buy the home when the lease ends or earlier if they so choose. If they decide to move forward with the purchase, they’ll work with their lender to qualify for a mortgage that covers the remaining purchase price of the property.

If the tenant decides not to buy the home, the owner keeps all of the money paid during the lease, including any upfront option fee. The owner could put the house back on the market or find new tenants.

Are you ready to start the mortgage process? Contact a Home Loan Expert to get started!

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This Post Has 13 Comments

  1. We are trying to look at our options for a rent to own, our problem is their mortgage payment is $1200. Since it says the “fair market rent price” is the $1200 not necessarily what we would pay?

    1. Hi Lauri:

      The way rent to own works is that you get a credit from the sellers based on the rent you paid. So it would be based on fair market rental value and not necessarily the mortgage payment. The problem I think you’re likely to run into is that in many areas, it’s cheaper on a monthly basis to buy than rent, so you’ll likely pay more for fair market rental value.

      Thanks,
      Kevin

  2. Hi, I am looking at this program for my daughter Sarah Borg and partner and would like as much information to be informed as possible. The area she would be looking at is Craigieburn or even the new estate Donnybrook. Regards Catherine

    1. Hi Catherine:

      I’m not familiar with those areas, however, rent-to-own agreements all work pretty much the same way. We don’t get involved in the actual agreements themselves, but should she decide to buy the house at the end of the agreement, the rent credits can be used toward her down payment. On the plus side, the price of the house is locked in at the time of the agreement and she gets to try it out for the term of the agreement. On the downside, if she chooses not to buy the house, the landlord gets to keep whatever extra money was paid toward rent credits above and beyond the fair rental value of the home. It’s all about deciding whether it makes sense for her and her partner.

      Thanks,
      Kevin Graham

  3. If the option fee and any monthly rent above the base rent as agreed to between seller and buyer is returned when it comes time to purchase the house, I’m confused as to how the lender has any say on whether or not you can use those funds as the down payment. If the seller is returning the option fee and extra rent payments isn’t that basically just cash in hand for the buyer at closing?

    1. A lender wouldn’t necessarily care where you got the down payment as long as it wasn’t coming from anywhere illegal. It’s also not being returned, it’s being used toward the purchase.

  4. I am a potential seller and have a few questions:
    What is percent of earnest money that should be requested of serious buyer and how is that determined ?
    Can I get a copy of their renter’s insurance on house and what should I demand that they have, or is this a privacy issue ?
    I live in hurricane area; if house is damaged by flood or wind, what am I responsible for; ex.-placement of renter, clean-up & rebuilding ?
    Are there any other issues or questions I need to be asking and to whom should I ask?

    1. Hi Pamela:

      We don’t offer any financing on rent-to-own properties, but I’m going to try it out for you as much help as I can. We tell people in typical purchase situations to think about bring down 3%–5% of the purchase price because it’s a competitive market for homes. Ultimately though, you can negotiate that. It’s your house and your transaction. I think it’s not unreasonable to ask to see renters insurance. Placement of the renter in a damage situation would be up to you and the renter to negotiate. You could also try to negotiate who pays for what maintenance. However, you’re ultimately responsible for any damage and repairs to the home until they take full possession of the title.

      Thanks,
      Kevin Graham

  5. Thanks for the article. We have tenants for a rent to own, and they are backing out. Mainly because he got demoted at work. My husband and I did a walk through before there lease is up, to see what damages were done. They have a dog and we did not charge them a fee., because they swore he was house broke. Plus we agreed to fix any appliance or anything else unless they caused the damage. When we did the walk through they painted both the children’s a bright pink and teal. They put some kind of frost on one of the wibdows. And they pulled our rose bush out, and put an above ground pool in the back yard. The carpets also had spills and smelled like dog. We only made them give us a depisit of $1,000 on a very nice home built in 2006. The house was professionally painted inside and out, and the carpet was brand new. Could we use any of there deposit to fix it up to sell? We didn’t have them out any money down, just the security deposit. Thanks so much!!

    1. Hi Courtney:

      If they violated the terms of the contract you have with them, you’re under no obligation to give them the deposit back if that’s the question.

      Thanks,
      Kevin Graham

  6. You say the rent credit and option fee can be applied toward the downpayment – are there limit on this? Can it make up the entire down payment? Or only a portion of it?

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