What Are the Pros and Cons of Rent-To-Own Homes?
If you want to buy a home but can’t qualify for a mortgage, renting to own might be a good solution. With a rent-to-own agreement, you lease a home with the intention of buying it at the end of a set amount of time.
See: 3 Things You Must Do When Your Savings Reach $50,000
Rent-to-own agreements differ from one deal to the next. Find out what those differences are and whether you’re a good candidate for this type of transaction.
How Does Rent-To-Own Work?
A rent-to-own contract can be structured in one of two ways: as a lease option or as a lease purchase. A lease option gives you a choice to buy the house at the end of the lease term. A lease purchase obligates you to buy it. In either case, you save for your house while you rent.
Lease Option
A lease option, also called a lease with an option to buy, consists of a lease agreement and an option agreement that gives you the right to buy the home at the end of the lease term. Here’s how it works:
You enter into a lease option contract with the property owner. For this example, the home has market-value rent of $1,500 and a three-year term. You and the property owner agree on a $250,000 sale price.
You pay an option fee for the right to purchase the home later. In this example, assume the option fee is $5,000.
In addition to the $1,500 market-value rent, you pay $200 each month. The property owner credits the extra $200 toward your future purchase.
If you decide to purchase the home at the end of the three-year lease term, you enter into a purchase agreement with the property owner. You’ll already have paid $7,200 ($200 per month x 36 months) toward the down payment — or $12,200 if the contract calls for the option fee to be credited toward the purchase — but would be responsible for any additional down payment required by the purchase agreement or your mortgage lender.
If you decide not to purchase the home, you’ll forfeit your $7,200 in rent credits and your $5,000 option fee.
If you’re unable to finish out the lease term, you’ll forfeit the option fee and any rent credits you’ve accumulated.
Lease Purchase
By signing a lease purchase agreement you’re agreeing to purchase the home after the lease term. It works like this:
You and the property owner sign a contract that consists of a lease agreement and a purchase agreement. It contains the details of both transactions, including the purchase price and the date by which you must purchase. For this example, assume a $1,500 market-value rent, five-year lease term and $250,000 sale price.
In addition to the $1,500 market-value rent, you pay $200 each month. The property owner credits the extra $200 toward your future purchase.
You’ll be responsible for the cost of maintenance and repairs during the lease term.
You’re legally obligated to purchase the home, at the agreed-upon price, at the end of the lease term. You’ll already have paid $12,000 ($200 per month x 60 months) toward the down payment, but you are responsible for any additional down payment required.
In the event you’re unable to purchase the home at the end of the lease term, you’ll forfeit your $12,000 in rent credits. Depending on the terms of your purchase agreement, the property owner might also be able to sue you for breaching the contract.
Failing to finish out the lease term results in the loss of any rent credits you’ve paid and could subject you to legal action for breaching the purchase agreement.
Some rent-to-own agreements let you and the property owner settle on a sale price after the lease term ends.
How To Find a Rent-To-Own Home
If you find someone who had a home on the market that didn’t sell, they might be open to the rent-to-own process. That said, you might find it difficult to find someone who’s willing to offer a rent-to-own agreement where you want to live. Rent-to-own agreements are more common in transitional areas and less desirable locations.
Entering a Rent-To-Own Agreement
You and the property owner must negotiate several things before you sign a contract:
Length of the rental period
Whether to set a purchase price upfront or when the lease ends
Option fee amount and whether it can be refunded or credited toward the purchase
Rent amount
Rent credit to be added to rent payment
Responsibility for maintenance and home repairs
Pros of Rent-To-Own Homes
Potential buyers ask, “Is rent-to-own worth it?” Although renting to own might not be the best option for everyone, it has certain advantages:
If you can’t get a mortgage right now because your credit is shaky or you don’t have enough money for a down payment, you can live in the home you want to purchase while you improve your finances.
You automate saving for a down payment by paying monthly rent credits in addition to your rent.
Cons of Rent-To-Own Homes
Like everything else, the rent-to-own process has downsides. See if one of these is a deal breaker for you:
You need to find a landlord who’s willing to give you a rent-to-own agreement, which might be tough in the location you want.
The tenant is usually responsible for the home’s upkeep as part of a lease purchase, which means you must pay to maintain someone else’s home.
If you’re unable to purchase the home at the end of the lease term, you’ll lose your rent credits and, perhaps, your option fee.
Rent-To-Own Alternative
Rent-to-own is a risky way for tenants to purchase a home, and it could leave you in a worse financial position at the end of the lease term than when you started. Consider forgoing rent-to-own and asking the owner to grant you the right of first refusal instead. That way, you reserve the right to buy the home at the owner’s asking price after the lease ends, but you’re not obligated to. In the meantime, you can save up for a down payment on your own, with no risk of losing your money if the purchase doesn’t work out.
Rent-to-own isn’t the right choice for everyone, but it can get you into your dream home sooner and let you put down roots in the community even before you buy. Because there is no standard rent-to-own contract, make sure you negotiate the best terms when you and the property owner draw one up, and have an attorney review it before you sign.
Barb Nefer contributed to the reporting for this article.
This article originally appeared on GOBankingRates.com: What Are the Pros and Cons of Rent-To-Own Homes?
