In your average home purchase, a buyer presents an offer, it is accepted by the seller, escrow closes and to top it all off the property and its title changes hands. An alternative solution to buying a home the conventional way is setting up a rent-to-own or lease-to-own contract with your landlord or a current homeowner.
If you are considering rent-to-own with the property you’re currently renting, you’ll need to take these steps. But first, let’s discuss how rent-to-own works and under what circumstances it can be a good investment for buyers.
How rent-to-own works
First of all, every scenario is different because you draw up your own contract with the current homeowner. When buyers sign this kind of contract, they agree to rent the home for a set amount of time before exercising an option to purchase the property when or before the lease expires. You get to move in right away and usually a specific timeline is set (1-3 is common) after which the buyer can purchase the house from the seller.
Logistics of the Contract Agreement
- Set a purchase price. In some cases, a buyer and seller agree on a purchase price when the contract is signed, basing it off of current market value with the expectation that the property will appreciate. Both parties could alternatively agree to set a purchase price when the lease expires.
- The buyer pays a fee called option money, giving him or her the opportunity to purchase the house in the future. This can range anywhere from 2.5% to 7% of the purchase price. This may or may not be rolled into your future down payment (this depends on the terms of your contract).
- Set rent. During the term of the lease, the potential buyer pays the seller a specified amount of rent. In many contracts, a percentage of each monthly rent payment called rent credit is applied to the purchase price. Factoring in these credits often makes the monthly payments slightly higher than the “going rate” for regular rentals. For the buyer, they act as down payments on the property; for the seller, they act as compensation for having taken the property off the market.
- Discuss maintenance costs. The potential buyer typically is responsible for basic property maintenance and repairs to prepare for homeownership. Things like homeowner’s association fees, property taxes, and insurance could be paid by the seller or buyer, depending on the contract terms once again. Legally, however, the seller is ultimately still responsible for these fees.
When it’s a good idea
- When you need to work on your credit. Maybe your credit score is just starting to recover, but you need more time to pay down debts for a couple of years. With rent-to-own, you could start investing in a home while you bring up your score.
- You’re close, but not quite ready to secure a mortgage. You might have a good job with a significantly bigger salary, but you haven’t been there long enough for a lender to consider it a stable source of income. Or maybe you’re self-employed and you’re still building a reliable track record. Rent-to-own allows time to build personal wealth and financial credibility while working toward your homeownership goals.
- When you know you’re going to buy when the lease expires. If you’re not ready to buy when the lease expires, then you will lose any rent credit, i.e. investment, you’ve put into the home.
When it’s a bad idea
- Your financial future is unsure. Rent-to-own offers a great option for buyers who are just outside of buying reach. But if your financial future is unstable and you could still be reaching in a few years, then you’re wasting your money on overpriced rent.
- You can’t find a place you love. Limited properties are available for rent-to-own. You are much more likely to find the perfect house if you are searching for all available homes for sale in your local market.
- You can’t trust the seller. Sadly, the rent-to-own universe is rife with predatory landlords who have no intention of ever selling their property, and who are just trying to collect above-market rent and eventually make off with your nonrefundable option deposit. An owner could make the contract become void if the buyer is late on one payment or evict the buyer for not doing repairs.
Before you enter into any rent-to-own agreement, consult a real estate professional and perform the same due diligence you would if you were purchasing any other property. If you can afford to buy a home traditionally by securing a mortgage loan, do it. But if you need more time and you’re ready for a house today, rent-to-own could be just what you’re looking for in a home investment.
We can help you make a plan for your real estate future. Reach out to a First Team Real Estate agent in your neighborhood for help navigating your unique situation.