The housing market is tough right now. Many buyers are competing to find homes. Those who are in worse financial positions face a harder time getting a home. As many homebuyers are struggling, many are turning to alternative financing methods. This is where the opportunity of a Rent-to-Own can come into play. This may be a great alternative option to consider when trying to buy a house!
What is a Rent-to-Own
The name perfectly describes the setup. First, you will rent the home before you own the home. Typically for one to three years, the homebuyers will have a lease. The lease is to be in place until it is time to purchase the house at the price set during the initial setup. There are costs associated with a Rent-to-Own agreement as well!
Not only are there costs that are associated with a Rent-to-Own agreement, but you will likely pay more in rent and for the final price of the home. For example, if the normal rent price of a home would be $1,000 a month, then those in a Rent-to-Own agreement would pay $1,200.
Even though that sounds like an immediate disadvantage to the buyer, that’s actually not the case! Instead both parties actually benefit. Buyers that consider Rent-to-Own agreements usually consider this option due to their lack of income, credit issues, or due to their down payment.
On the other hand, sellers typically consider Rent-to-Own agreements because of the fact that they are struggling to sell the home and/or want to stop dealing with the mortgage payment. Since sellers may be experiencing a difficult time with the home selling process, then it could benefit them to consider another financing option like a Rent-to-Own!
What Makes Up a Rent-to-Own Agreement?
There are two components of a Rent-to-Own agreement. These are:
- The lease portion.
- The purchase portion.
Not every agreement is the same so some contracts may be prepared in one document or in two separate ones.
Understanding the Lease Portion
There will be a lease portion to your Rent-to-Own. Even if you intend to purchase the home at the end of the lease, it is still set up like a traditional rent agreement. That means the title of the house still belongs to the landlord. The “home buying” process would begin at the end of the lease.
The lease portion of the agreement will detail the obligations of both the renter and the landlord. Just like a normal lease, it is important to know all of the fine details within your agreement. It is important that you do not sign anything that you cannot handle. Even though this is a lease, you should get a Rent-to-Own professional to help with the signing process.
What is an Option to Purchase Document?
This is a document that gives tenants the ability to purchase the rental property within a specified time window for a fee (the option fee). How the fee is paid is up to the agreement terms. Some may pay the fee upfront while others can pay it in the form of an increased rent which is applied to the home.
This document provides the renters the ability to purchase the home. If they don’t then the seller can benefit. The seller may not have to provide a refund of any of the extra money paid. The only downside that the seller faces if the renter doesn’t buy is the fact they are still trying to sell the home. That means they will have to begin the home selling process all over again.
How is a Rent-to-Own Lease Agreement Different Than a Normal Lease?
Even though these leases have a similar setup, they can have some key differences.
The Payment Arrangement
In both a normal lease and a Rent-to-Own lease, the tenant is responsible for paying the rent accurately and on time. However, rent is usually more expensive in a Rent-to-Own lease agreement. The rent funds can be placed into an escrow account to build towards the purchase price of the home. The landlord is responsible for handling the escrow account. If properly managed, the tenant can end up building equity in the home during the lease agreement.
Tenants have a higher likelihood of needing to be responsible for the cost of home repairs in a Rent-to-Own lease agreement. The reason for this is because it’s the goal of the renter to eventually own the home. It also provides incentive for the renter to take better care of the home since it will eventually be theirs.
The landlord owns the home during the leasing period of a Rent-to-Own agreement. So it is important to make sure to fulfill all of the lease obligations during this time. If the tenant breaks the lease then it can become null and void. The tenant faces forfeiting the option fee and any extra money paid to the landlord. The tenant also runs the risk of not getting reimbursed for any home repairs covered during their residency.
Home Inspection and Appraisal
Your goal is to own the home at the end of your Rent-to-Own agreement. That is why you want to consider ordering a home inspection even before entering the lease. It is important to do this because you want to be proactive in your home ownership. A home inspection can show if the home is in good condition so that the renter will not have to cover any major repairs. It can also provide the potential tenant some insight if the home is worth purchasing at the end of the lease. You don’t want to enter an agreement where you are obligated to purchase a home that you then find out is not as good as you thought. Some states may have real estate disclosure laws that mandate landlords to disclose any relevant information about the condition of the property.
Should You Consider a Rent-to-Own Agreement?
Possibly! Everyone has a unique financial situation. That is why you should consider the benefits and drawbacks whether you are a renter or a seller.
Benefits for Buyers
This can be a great opportunity for tenants to work on the goal of home ownership while still being able to work on their financial situation. People typically use the one to three years of their lease portion to focus on their credit, improve their income, or save for a better down payment. It can even provide tenants the opportunity to work on building equity. It can also provide buyers the benefit to walk away if they can’t or don’t want to purchase the home once the lease ends.
Benefits for Sellers
A Rent-to-Own agreement can benefit sellers just as it can benefit buyers. During the lease period, the landlord can enjoy themselves. They have a long-term tenant that deals with property repairs, maintenance of the property, and pays rent. If the tenant doesn’t purchase the home then the landlord can keep the money from the option fee as well as the escrow account funds.
What’s the Catch?
There is no catch! As long as you understand the terms and conditions of the agreement before entering it. There can be instances where a Rent-to-Own agreement isn’t the best setup for your situation.
If at the end of the Rent-to-Own agreement, the tenant doesn’t buy the home then that can cause some issues. The tenant ends up having paid extra money for no reason. The renter could also have been responsible for paying the cost of repairs and maintenance during their lease term. If they end up not buying the home, they only benefited the seller at no benefit to themselves.
Not every Rent-to-Own agreement is set up the same. Some Rent-to-Own agreements state that the tenant must purchase the home at the end of the lease. If you aren’t able to fulfill this expectation, then you shouldn’t enter the agreement.
Sellers should also be aware that there are some risks associated with a Rent-to-Own agreement. If the renter does not purchase the home at the end of the agreement then they push back when they can sell the home. If the seller is looking to sell the home quickly then this can be a drawback.
What to Watch Out For?
If a tenant doesn’t purchase the home at the end of the lease then it is likely due to the same issues they were dealing with originally. A lack of income, credit issues, or the down payment may not be at the place that is necessary for a home purchase.
If you are interested in considering this type of agreement then you should get the help of a professional during the signing process. They will be able to help you with all of the paperwork to make sure you get a deal that is fair to all parties.
There are many types of Rent-to-Own agreements. Not every contract is the same. That is why it can benefit you to seek the help of a professional when dealing with this home buying option. A professional can ensure that both the seller and the buyer do not enter an agreement that is unjust or unfair. Take your time, make sure to understand the terms, and a Rent-to-Own may be a great option for you to consider if you need to work on your credit, income, or down payment!