Have you been hearing about renting to own a home and wondered how it works? You are not alone, as many folks do online searches trying to understand the process involved. If you have some problems qualifying for a mortgage, a rent-to-own arrangement can seem like the perfect solution.
You avoid the need for a good credit score and don’t have to save a down payment. Two major stumbling blocks are removed for those who would really love to live in a particular property but might not be in a financial position to do so.
As great as renting to own might first appear, there are some downsides which you might not be aware of. We’ll take a look at the benefits and the problems when renting to own.
When you pay rent to your landlord, a portion of the monthly fee goes toward the purchase of the house. You will have to sign an agreement with the landlord covering how long the rental period will last and other important terms of the contract.
When the rental period ends, which is commonly between one and five years, you will have the chance to purchase the home. This can be great if you are unable to buy now, and it can be an excellent arrangement for the seller in a slow market. Sometimes the owner might not be ready to sell but would like an income stream—a win-win!
Sometimes a rent-to-own agreement can include a lease-to-own clause. This can protect the seller by obligating the tenant to purchase at the end of the agreement term. The lease-to-own clause can either be an option to purchase or a legally-binding contract to buy. Whichever of these contracts the seller wants you to sign, you should consult an attorney first.
Pros and Cons of Rent to Own
There are good things about renting to own, for both the buyer and the seller, but there are some significant potential pitfalls as well.
Pros of Rent to Own
For the tenant, it allows them to move into a home that they want to own even if their financial situation isn’t good enough to qualify for a mortgage. While they are living in the home, they have the opportunity to save for a down payment and improve their credit. It also means that the purchase price is fixed even if the value increases over the rental term.
From the landlord’s perspective, it gives them a greater opportunity to sell the home in a slow market. They could get more money for the property because of the advantages this type of sale offers to buyers. If the seller doesn’t take up the option to purchase at the end of the term, then the landlord gets to keep the extra money which has been paid.
Cons of Rent to Own
There are some significant risks for tenants under this type of agreement. If they are unable to qualify for a mortgage when the rental period ends, they will have spent more to live in the home than they would in a normal rental. They won’t get this money back, which will leave them with more of an uphill struggle to find a down payment in the future.
If the landlord doesn’t use the rental money to pay the mortgage, the property could end in foreclosure. The renter will lose the chance to purchase the home and they will also lose their place to live.
There is also the risk of the property’s value falling. This will leave the buyer paying more than the home is worth, and they may find it difficult to get a mortgage for the full amount.
The seller can lose out if the house prices rise and they have agreed to a lower price. There is also the possibility that they won’t sell the house at the end of the agreement and have to begin the sales process again.
The Rent-to-Own Process
The first stage is to work with the seller to agree to the terms of the contract. This will include the eventual purchase price, the rental cost, the maintenance responsibilities and the length of the agreement.
There will likely be more to pay than a normal rental agreement, including extra money that goes toward the purchase and a fee for the option to buy. This fee could be anywhere from 1 to 5 percent of the agreed value of the home and won’t be refundable.
As a buyer, you should treat an agreement like this with the same importance as if you were buying a home the normal way. Think of the money you are putting up as akin to losing your earnest money when buying a home. It is highly advisable to think about the transaction in these terms. For example, getting a home inspection and having the value appraised are two items that should be at the top of your due diligence list.
When you have signed on the dotted line, you have to make sure you make all your rental payments on time. If you don’t, you risk breaching the terms of the agreement and losing the chance to purchase the home.
Final Thoughts on Lease to Own
The choice of renting to own brings with it many risks for the buyer and a few for the seller. When entering into an agreement like this, careful consideration needs to be given as a buyer and you have to make sure you will be in a position to purchase when the contract ends.
You may find that the risks outweigh the chance to purchase, and waiting longer may be the better option. There are upsides and downsides for both parties in these type of real estate agreements. Hopefully, you now have a better understanding on how the rent-to-own process works, so you can make an informed decision.
Bill Gassett is a nationally recognized real estate leader who has been helping people buy and sell Metrowest Massachusetts real estate for the past 33 years. He has been one of the top RE/MAX REALTORS® in New England for the past decade. In 2018, he was the No. 1 RE/MAX real estate agent in Massachusetts. He works for RE/MAX Executive Realty in Hopkinton Mass.