If you’re like most homebuyers, you’ll need a mortgage to finance the purchase of a new house. To qualify, you must have a goodcredit scoreand cash for adown payment.Without these, the traditional route to homeownership may not be an option.
There is an alternative, however: arent-to-own agreement, in which you rent a home for a certain amount of time, with the option to buy it before the lease expires. Rent-to-own agreements typically consist of two parts: astandard lease agreement and an option to buy.
Here’s a rundown of what to watch for and how the rent-to-own process works. It's more complicated than renting, and you'll need to take extra precautions to protect your interests.Doing so will help you figure out whether the deal isa good choice if you're looking to buy a home.
Key Takeaways
- Arent-to-own agreement is a deal in which you commit to renting a property for a specific period of time, with the option of buying it before the lease runs out.
- Rent-to-own agreements include a standard lease agreement and also an option to buy the property at a later time.
- Lease-option contracts give you theright to buy the home when the lease expires, while lease-purchase contracts require you to buy it.
- You pay rent throughout the lease, and in some cases, a percentage of the payment is applied to the purchase price.
- With some rent-to-own contracts, you may have to maintain the property and pay for repairs.
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What Are Rent to Own Homes?
Rent-to-own homes are homes that include a clause in the rental agreement which either gives you the option to buy or an obligation to buy after a certain time period. You make rent payments each month and a portion of those payments can count toward your down payment. Should you decide to buy, the excess money can be applied to the home purchase.
Renting to own can be an appealing concept for people who are interested in owning property but have thus far been shut out of the traditional homebuying process. If you don't have a sizable down payment, for instance, or your credit score is too low to qualify for a mortgage, renting a property with the intention to buy it can give you time to save and work on improving your credit rating.
Nonrefundable Upfront Fees
In a rent-to-own agreement, you (as the buyer) pay the seller a one-time, usually nonrefundable, upfront fee called the option fee, option money, or option consideration. This fee is what gives you the option to buy the house by some date in the future. The option fee is often negotiable, as there’s no standard rate. Still, the fee typically ranges between 1% and 5% of the purchase price.
Lease-Option vs. Lease-Purchase
It’s important to note that there are different types of rent-to-own contracts, with some being more consumer friendly and flexible than others. Lease-optioncontracts give you theright, but not the obligation, to buy the home when the lease expires. If you decide not to buy the property at the end of the lease, the option simply expires, and you can walk away without any obligation to continue paying rent or to buy. This is not always the case with lease-purchase contracts.
To have the option to buy without the obligation to buy, it needs to be a lease-option contract. Because legalese can be challenging to decipher, it’s always a good idea to review the contract with a qualified real estate attorney before signing anything, so you know your rights and exactly what you’re getting into.
Watch out for lease-purchase contracts—you could be legally obligated to buy the home at the end of the lease, whether you can afford to or not.
Steps to Buy a Rent-to-Own Home
Entering into a rent-to-own agreement typically means signing a formal legal contract. The contract should specify the terms of the agreement and whether you're obligated to buy the home or simply have the option to do so. There are several key pieces of information that a rent-to-own agreement should generally include.
Agreeing on the Purchase Price
Rent-to-own agreements should specify when and how the home’spurchase priceis determined. In some cases, you and the seller will agree on a purchase price when the contract is signed, often at a higher price than thecurrent market value. In other situations, the price is determined when the lease expires, based on the property's then-current market value. Many buyers prefer to “lock in” the purchase price, especially in markets where home prices are trending up.
Applying Rent to the Principal
You’ll pay rent throughout the lease term. The question is whether a portion of each payment isapplied to the eventual purchase price. As an example, if you pay $1,200 in rent each month for three years, and 25% of that is credited toward the purchase, you’ll earn a $10,800 rent credit ($1,200 x 0.25 = $300; $300 x 36 months = $10,800). Typically, the rent is slightly higher than the going rate for the area to make up for the rent credit you receive. But be sure you know what you're getting for paying that premium.
In some contracts, all or some of the option money you must pay can be applied to the eventual purchase price at closing.
Rent-to-Own Home Maintenance
Depending on the terms of the contract, you may be responsible for maintaining the property and paying for repairs. Usually, this is the landlord's responsibility, so read the fine print of your contract carefully.Because sellers are ultimately responsible for any homeowner association fees, taxes, and insurance (it’s still their house, after all), they typically choose to cover these costs. Either way, you’llneed a renter’s insurance policyto cover losses topersonal propertyand provide liability coverage if someone is injured while in the home or if you accidentally injure someone.
Be sure that maintenance and repair requirements are clearly stated in the contract (ask your attorney to explain your responsibilities). Maintaining the property, e.g., mowing the lawn, raking the leaves, and cleaning out the gutters, etc., is very different from replacing a damaged roof or bringing the electrical wiring up to code. Whether you’ll be responsible for everything or just for mowing the lawn, have the home inspected, order an appraisal, and make sure the property taxes are up to date before signing anything.
Buying the Property
What happens when the contract ends depends partly on which type of agreement you signed. If you have a lease-option contract and want to buy the property, you’ll probably need to obtain a mortgage (or other financing) in order to pay the seller in full.
Conversely, if you decide not to buy the house—or are unable to secure financing by the end of the lease term—the option expires and you move out of the home, just as if you were renting any other property. You’ll likely forfeit any money paid up to that point, including the option money and any rent credit earned, but you won’t be under any obligation to continue renting or to buy the home.
If you have a lease-purchase contract, you may be legally obligated to buy the property when the lease expires. This can be problematic for many reasons, especially if you aren’t able to secure a mortgage. Lease-option contracts are almost always preferable to lease-purchase contractsbecause they offer more flexibility and you don’t risk getting sued if you are unwilling or unable to buy the home when the lease expires.
Treat the process the same as you would if you were outright buying a home: Do your due diligence, research the area, compare prices with other nearby homes, research the contract, and research the seller's history.
If you are experiencing financial difficulty related to COVID-19, programs for renters and homeowners that prevent foreclosure, eviction, and provide mortgage payment relief are available from the federal government, states, municipalities, and private lenders as part of the coronavirus stimulus package.
Who Are Rent-to-Own Homes Right For?
A rent-to-own agreement can be an excellent option if you’re an aspiring homeowner but aren’t quite ready, financially speaking. These agreements give you the chance to get your finances in order, improve your credit score, and save money for a down payment while “locking in” the house you’d like to own. If the option money and/or a percentage of the rent goes toward the purchase price, which they often do, you also get to build some equity.
While rent-to-own agreements have traditionally been geared toward people who can’t qualify for conforming loans, there’s a second group of candidates who have been largely overlooked by the rent-to-own industry: people who can’t get mortgages in pricey, non-conforming loan markets. “In high-cost urban real estate markets, where jumbo (nonconforming) loans are the standard, there is a large demand for a better solution for financially viable, creditworthy people who can’t get or don’t want a mortgage yet,” says Marjorie Scholtz, founder and CEO of Verbhouse, a San Francisco–based start up.
“As home prices rise and more and more cities are priced out of conforming loan limits and pushed into jumbo loans, the problem shifts from consumers to the home finance industry,” says Scholtz. With strict automatic underwriting guidelines and 20% to 40% down-payment requirements, even financially capable people can have trouble obtaining financing in these markets.
“Anything unusual—in income, for example—tosses good income earners into an ‘outlier’ statusbecause underwriters can’t fit them neatly into a box,” says Scholtz. This includes people who have nontraditional incomes, are self employed or contract workers, or don't have a U.S. credit history (e.g., foreign nationals)—and those who simply lack the huge 20% to 40% down payment banks require for nonconforming loans.
High-cost markets are not the obvious place you'll find rent-to-ownproperties, which is what makes Verbhouseunusual. But all potential rent-to-own home buyers would benefit from trying to write its consumer-centric features into rent-to-own contracts: The option fee and a portion of each rent payment buy down the purchase price dollar-for-dollar, the rent andpurchase price are locked in for up to five years, and participants can build equity and capture market appreciation, even if they decide not to buy. According to Scholtz, participants can “cash out” at the fair market value: Verbhouse sells the home and the participant keeps the market appreciation plus any equity they’ve accumulated through rent “buy-down” payments.
Before You Sign the Contract
Signing off on a rent-to-own agreement can create certain legal obligations both for you and the property seller. Here are a few additional tips to consider before you sign.
Choose the Right Terms
It's important to read the fine print on a rent-to-own agreement to understand whether it's lease-option or lease-purchase. Again, a lease-purchase agreement could put you in the position of being forced to buy the home, which may be problematic if you find later that you're unable to afford it or simply don't want to own it.
Get Help
Hiring a qualified real estate attorney to explain the contract can help you understand your rights and obligations in a rent-to-own agreement. You may want to negotiate some points before signing or avoid the deal if it's not favorable enough to you.
Research the Contract
Rent-to-own contracts can be complicated and it's vital that you understand all the finer details. For instance, take time to review:
- The deadlines (what is due when)
- The option fee and rent payments–and how much of each applies toward the purchase price
- How the purchase price is determined
- How to exercise your option to buy (for example, the seller may require you to provide advance notice in writing of your intent to buy)
- Whether pets are allowed
- Who is responsible for maintenance, homeowner association dues, property taxes, and the like
- What "maintenance" means: just mowing the lawn and raking, etc. or serious repairs, such as fixing a roof.
Research the Home
It's essential to perform certain due diligence before buying any home, including rent-to-own properties. Ordering an independent appraisal, obtaining a property inspection, making sure the property taxes are up to date, and ensuring there are no liens on the property can help you make an informed decision about whether you should buy the home.
Research the Seller
Working with the right seller can make a rent-to-own experience a positive one and it's helpful to look into the property owner's background before committing. For instance, you may want to check the seller’s credit report to look for signs of financial trouble and obtain a title report to see how long the seller has owned the property—the longer they’ve owned it and the more equity, the better.
Ask the Right Questions
If there's anything you're unsure of with a rent-to-own agreement, it's better to ask questions sooner rather than. later. For instance, it's a good idea to know under which conditions could you lose your option to buy the property. Under some contracts, you lose this right if you are late on just one rent payment or if you fail to notify the seller in writing of your intent to buy.
How Is Rent to Own Different Than Buying a House?
Renting to own is basically a hybrid approach to buying a home where all or a portion of a lease payment goes to building equity in a home over time. It is usually a process by which the owner of a home allows a renter to build equity without having to make a down payment or secure a mortgage.
What Are the Advantages of Rent to Own Agreements?
Renting to own can allow a person to begin building equity in a home they like without having to take out a mortgage or come up with a large down payment. This can be especially beneficial for those without the financial means to make a down payment due to lack of savings or qualify for a mortgage due to low credit scores.
What Should Be Considered When Renting to Own?
Rent to own contracts can vary significantly and require due diligence on the part of the renter. It's important to research the contract (possibly with the assistance of a real estate attorney), research the home (with an appraisal and inspection) and research the seller.
The Bottom Line
A rent-to-own agreement allows would-be home buyers to move into a house right away, with several years to work on improving their credit scores and/or saving for a down paymentbefore trying to get a mortgage. Of course, certain terms and conditions must be met, in accordance with the rent-to-own agreement. Even if areal estate agentassists with the process, it’s essential to consulta qualified real estate attorney who can clarify the contract and your rights before you sign anything. And if you decide that you'd like to buy outside of a rent-to-own agreement, it may be helpful to compare the best mortgage rates to find a great deal on a home loan.
FAQs
What is the downside of rent to own? ›
A major disadvantage of renting to own is that renters lose their down payment and other non-refundable charges if they decide not to purchase the home. Some sellers may even take advantage of renters by making it difficult or unappealing to purchase the home — with the goal of keeping the down payment.
What are 3 advantages to owning your own home as opposed to renting? ›- A good long-term investment: Homes can lose value, but it doesn't happen often. ...
- Low interest rates: Rarely will we see interest rates like we are seeing now. ...
- Building equity: Your equity is the difference between what you can sell the home for and what you owe.
There is no definitive answer as to whether renting or owning a home is better. The answer depends on your own personal situation—your finances, lifestyle, and personal goals. You need to weigh out the benefits and the costs of each based on your income, savings, and how you live.
Why is it better to own then rent? ›Homeowners get to capitalize on their home's equity, which accumulates over time. They also get to enjoy tax deductions on mortgage interest payments and other homeowner expenses. Paying off your home will also enable you to live mortgage-free, and this will support a comfortable retirement.
What are 3 advantages of rent-to-own? ›- It allows you to save money for a down payment. Renting-to-own can be a great way to save money for a down payment and give that home a test drive to make sure you like it. ...
- You can save on repair costs. ...
- It offers you the option to buy or move.
Buying a house gives you ownership, privacy and home equity, but it's expensive when it comes to repairs, taxes, interest and insurance. Renting an apartment is lower maintenance and more flexible, but you may have to deal with rent increases, loud neighbors or a grumpy landlord.
Is it cheaper to buy than rent? ›Even as rents continue to climb across the country, renting is still cheaper than monthly payments for a purchased home in 45 of the 50 largest US cities in December, according to a report from Realtor.com. Renting costs nearly $800 less per month than buying, on average.
What are the problems faced by the buyer? ›It requires a lot of planning, searching, and networking. These are only a few problems that home buyers face when they are planning on buying a house. There are many other issues like the appreciation cost in the area, bad credit score, and false promises by builders/developers.
What are the three main disadvantages of renting a home? ›- Your landlord can increase the rent at any time.
- You cannot build equity if you're renting a property. ...
- There are no tax benefits to renting a property.
- You cannot make any changes to your house or your apartment without your landlord's approval.
- Many houses available for rent have a “No Pets” policy.
- Be Realistic About Budgets. ...
- Turn Up on Time To Property Viewings. ...
- Present Yourself Well. ...
- Have Your Documentation Ready. ...
- Don't Be Afraid to Ask Your Landlord Questions.
How does rent to buy work? ›
You rent a property and pay the going rate for up to five years. After two years you have the option to buy the property. If you decide to buy you will receive 25% of the rent you have paid and 50% of any increase in the property's value since you moved in to use as a deposit on the purchase.
What to say when applying to rent a house? ›- Brief introduction to yourself;
- Indicate your strong interest in the property / room;
- Indicate that you have the means to pay for the rent every month, on time;
- Give a reference from previous landlords or employers;
- Finally, suggest that you would like to view the property asap.
In some cases, buying does not make sense if your finances may not support it and a down payment for a home may take you years to save. Renting also affords one the flexibility to move if the need arises. You can often enjoy the lifestyle you want at a lower cost, especially in high-end real estate areas.
What is the 5 percent rule in rent vs buy? ›That said, the easiest way to put the 5% rule in practice is multiplying the value of a property by 5%, then dividing by 12. Then, you get a breakeven point for what you'd pay each month, helping you decide whether it's better to buy or rent.
Is owning a rental worth it? ›If you have your financial house in order, especially as interest rates climb, rental properties can be a good long-term investment, Meyer says. A rental property should generate income monthly, even if it's just a few dollars at first. Do the math to make sure the property you're considering is right for you.
Why would people use rent-to-own? ›Rent-to-own may be a good option for those with low credit scores, because it gives you time to work toward improving your score before you need to apply for a mortgage. If you don't qualify for a mortgage right now, you can use a rent-to-own agreement to start working on buying a house sooner rather than later.
Does rent-to-own affect credit score? ›How Do Rent-to-Owns Affect Your Credit? The only accounts that show up on your credit report—and, in turn, shape your credit score—are ones that are reported to the credit bureaus. Since rent-to-own agreements generally are not, they should have no impact on your credit.
Can I rent to buy from my landlord? ›Absolutely! If you're in a position to buy property and you're eager to stay in your current home, buying from your landlord can be convenient and may also save you money given that you won't have removal fees and may also be able to complete the sale without an estate agent.
Is it better to buy or rent when you are 70 years old? ›In theory, buying a house after retirement gets you more for your money than renting. However, homeownership also entails substantial financial risks. Issues such as fluctuations in market value, unexpected maintenance expenses, and insurance deductibles can increase costs over and above those of renting.
How much money should I save before buying a house? ›You may find as you start shopping for financing that many mortgage companies recommend you put at least 20 percent down. This is done for a few important reasons, though the main one is that with 20 percent down, you'll be able to avoid a monthly private mortgage insurance fee.
Is it cheaper to buy or build a house? ›
In general, buying an existing home is cheaper. According to the National Association of Home Builders and the U.S. Census Bureau the median cost to buy a house today is $410,600 which is $28,800 less than building one.
Is renting throwing money away? ›In the world of real estate, a common refrain is that if you're renting instead of buying, you're throwing your money away. I've had several realtors tell me that before… but is it true? The answer is no. Renting is not a waste of money.
What is the biggest mistake people make when buying a home? ›Not Checking Your Credit Report. Ignoring or not observing your credit score throughout the home buying process can lead to unchecked errors that could impact your loan approval or lead to less favorable loan rates and terms.
What are the two biggest complaints buyers have about sellers? ›- You don't understand my business.
- You don't listen.
Buyer abuse occurs when a buyer attempts to avoid paying for a legitimately purchased good or service. Merchants can be held liable for these charges, which means you could be out the goods or services, your time and the payment.
What are the risks of rent to rent? ›One of the many problems with 'rent to rent' is that if one tenant in a house share does not want to move out, it will take a long time to evict them, and if the other rooms are vacant during that time, someone – either the landlord or the rent-to-rent business – is sure to be losing money.
What are 5 things that should be included in a lease? ›- Security Deposits. ...
- Specific Payment Requirements. ...
- Late Rent Fees. ...
- Rent Increases. ...
- Notice of Entry. ...
- Rental Agreement Disclosures. ...
- Gas and Electricity Disclosure. ...
- Recreational Marijuana and Rentals.
- Fewer Upfront & Ongoing Costs. Buying and maintaining a home is expensive. ...
- Flexibility in the event you need to relocate or change homes. ...
- More Free Time. ...
- Access to Amenities. ...
- More Options. ...
- Community.
- Rental history.
- Current or previous employment.
- Parental guarantee letters if you are a student receiving money from your parents.
- Information on pets if you have them.
- Info on who will be renting with you and how many months you would like to lease the property.
- Any references that are valid.
- Get more from your existing landlords. Sometimes, you needn't have to look any further than what is already directly in front of you. ...
- Encourage referrals. ...
- Keep tenants happy. ...
- Go old school, build relationships.
What does a landlord look for in a tenant? ›
Landlords or agents usually make checks to see if you're a reliable tenant who can afford the rent. They must also check your immigration status.
How much deposit do you need for a rent to buy? ›The minimum deposit for a buy-to-let mortgage is usually 25% of the property's value (although it can vary between 20-40%). Most BTL mortgages are interest-only. This means you pay the interest each month, but not the capital amount. At the end of the mortgage term, you repay the original loan in full.
How are lease to own payments calculated? ›Lease-to-Own Formula
To calculate the monthly interest on a lease-to-own, multiply the loan amount by the annual interest rate, then divide by 12.
With rent to buy houses there is no interest to pay, so you will know exactly how much you are paying for the duration of the term. However if you choose not to buy the property and move out, then you will incur a financial loss on the deposit money you will have saved.
What should you ask on a rental application? ›- What date would you like to move in?
- Do you have pets?
- How long have you lived in your current home?
- Why are you moving?
- How many people will be living in the unit?
- How many people living with you smoke?
- What is your monthly income?
- Have you ever been convicted of a relevant crime?
To make a good impression on your landlord, you should describe yourself as the best tenant in a cover letter. Drop a few lines about your lifestyle and say what kind of person you are. If your background is not impeccable, provide a brief explanation of why you had issues in the past and what you did to fix them.
What makes you a great tenant answer? ›Respectful Behavior
Pay rent on time. Follow lease terms. Refrain from causing problems with other tenants or neighbors. Keep from damaging your property beyond normal wear and tear.
A major disadvantage of renting to own is that renters lose their down payment and other non-refundable charges if they decide not to purchase the home. Some sellers may even take advantage of renters by making it difficult or unappealing to purchase the home — with the goal of keeping the down payment.
Is it smart to rent out a house? ›Renting Your Home Could Provide Monthly Cash Flow
Plus, the market value of the home continues to increase over time. If the house is in good condition, in a favorable rental location, and you have adequate cash reserves, renting could be a wise decision.
Your landlord can't increase your rent during your fixed term unless you agree or your agreement allows it. If your agreement says your rent can be increased it has to say when and how it will be done. This is known as having a 'rent review clause'.
Is the 30% rent rule outdated? ›
The 30% Rule Is Outdated
The 30% Rule has roots in 1969 public housing regulations, which capped public housing rent at 25% of a tenant's annual income (it inched up to 30% in the early 1980s).
The Rule of 69 is a simple calculation to estimate the time needed for an investment to double if you know the interest rate and if the interest is compound. For example, if a real estate investor can earn twenty percent on an investment, they divide 69 by the 20 percent return and add 0.35 to the result.
What is a major disadvantage of owning rental property? ›The drawbacks of having rental properties include a lack of liquidity, the cost of upkeep, and the potential for difficult tenants and for the neighborhood's appeal to decline.
How much profit should you make on a rental property? ›Keep in mind, when it comes to real estate cash flow, calculating your expenses and rental property income will be your number one key to success. Anything around 7% or 8% is the average ROI. However, if you'd really like to succeed, you should always aim higher at around 15%.
Does owning rental property make money? ›Rental properties can be a great way to generate income, so long as your operating expenses aren't too high and your rent price is competitive. Rent payments, security deposits, move-in fees, and pet fees can also help cover your monthly expenses and leave money left over to save for future costs.
Is it better to own your own home or to rent? ›Homeownership is a better long-term investment
When you buy a home with a 30-year mortgage and make monthly payments, you will own a home to sell at the end. If you rent a property for 30 years, however, you won't ever get any of your monthly rent payments back.
Rent-to-own may be a good option for those with low credit scores, because it gives you time to work toward improving your score before you need to apply for a mortgage. If you don't qualify for a mortgage right now, you can use a rent-to-own agreement to start working on buying a house sooner rather than later.
Is owning rental property worth it? ›If you have your financial house in order, especially as interest rates climb, rental properties can be a good long-term investment, Meyer says. A rental property should generate income monthly, even if it's just a few dollars at first. Do the math to make sure the property you're considering is right for you.
What is a good age to buy a house? ›The best age to buy is when you can comfortably afford the payments, tackle any unexpected repairs, and live in the home long enough to cover the costs of buying and selling a home. Legally, you must be at least 18 in most states to buy a home.
Is it cheaper to buy a house or build it? ›In general, buying an existing home is cheaper. According to the National Association of Home Builders and the U.S. Census Bureau the median cost to buy a house today is $410,600 which is $28,800 less than building one.
What should your credit score be to rent a property? ›
While there is no minimum credit score to rent a house, you should aim for somewhere above 600. If you're seeking to rent in a high-demand area, you might need a score over 700. You might find more sympathetic landlords with rental apartments than houses if you have a low credit score.
Does your credit score go down if you don't pay rent? ›How Does Not Paying Rent Affect Your Credit? Not paying rent can affect your credit score negatively, making it drop. However, your landlord needs to report it, and oftentimes unpaid rent might stay off your credit report for a long time. This is because many landlords do not report unpaid rent to credit bureaus.
How high does your credit score have to be to rent a house? ›A good starting point for many landlords conducting a tenant screening seems to be at around a 620 or above to be eligible for consideration. You may have different criteria and may want to see a higher score.
Do you lose money by lease-to-own? ›You return the vehicle at lease-end, pay any end-of-lease costs, and walk away. The vehicle will depreciate, but its cash value is yours to use as you like. On the plus side, its future value doesn't affect you financially.
What is the difference between lease and lease-to-own? ›With a lease to own the buyer can opt out after the contract is up. Whereas a lease purchase the buyer is locked in to purchase. Each option has it's benefits and drawbacks depending on the given situation.
How are lease-to-own payments calculated? ›Lease-to-Own Formula
To calculate the monthly interest on a lease-to-own, multiply the loan amount by the annual interest rate, then divide by 12.
Keep in mind, when it comes to real estate cash flow, calculating your expenses and rental property income will be your number one key to success. Anything around 7% or 8% is the average ROI. However, if you'd really like to succeed, you should always aim higher at around 15%.
Are there tax benefits to owning a rental property? ›Main tax benefits of owning rental property include deducting operating and owner expenses, depreciation, capital gains tax deferral, and avoiding FICA tax. In most cases, income from a rental property is treated as ordinary income and taxed based on an investor's federal income tax bracket.