Everything You Need to Know About Renting to Own
If you don’t have the greatest credit score or a lot of cash on hand for a down payment, it can be tough to get a mortgage -- but don’t despair. If you still really want to own a home, one great option could be renting to own. While renting to own isn’t particularly common, and there a lot of variables to consider, it can still be a way for some to grab their slice of the American Dream without having to wait years to build up a down payment or good credit.
How Renting to Own Actually Works
If you’re seriously interested in renting to own, first, locate potential sellers who are willing to engage in a rent-to-own contract. Because these sellers may be difficult to find, ask real estate agents in your area. You may also look online to find a company that specializes in locating rent-to-own properties for potential tenants/buyers.
Once you find a rent-to-own property you like, consider the following:
Length of rental agreement: This will usually be about a 1-3 year period, after which this tenant can purchase the home.
Purchase price: How much will you likely be paying for the home? Make sure the estimate price is an amount you think you can handle (and get a home loan for).
Rental credits: In many rent-to-own agreements, a certain percentage of your monthly rent will be applied to the price of your home, if you do end up purchasing it. The amount of this varies, so you’ll want to check this out -- and perhaps negotiate a larger percentage, if possible.
Other terms and conditions: Rent-to-own contracts can actually be somewhat complex, so you’ll want to know exactly what you’re getting into. To make sure you’re not signing up for anything unfair, have a real estate attorney (or a similar kind of expert) check out the contract before you sign it.
How Option Money Places a Role in the Process
When it comes to rent-to-own properties, one of the biggest upfront expenses for the tenant/buyer is usually the option fee. An option fee, sometimes called an option consideration, is a one-time payment (typically set at around 3% of the home’s price), that allows the tenant/buyer to purchase the home at the pre-arranged date. Typically, there are two kinds of option fee contracts:
Lease-option: Gives the tenant/buyer the option, but not the obligation, to purchase the home after the specified period.
Lease-purchase: Depending on the contract’s specific wording, this contract could obligate the tenant/buyer to purchase the home after the specified period -- and there could be some kind of financial penalty if they do not.
In the vast majority of cases, signing a option contract and paying the option fee means that the seller cannot sell to anyone else during that time period -- meaning you have the exclusive right to purchase the home, at least until the contract runs out.
In addition, many contracts specify that all or part of the option money will go toward the purchase price of the home (just like rental credits), so this is something you’ll want to investigate and potentially negotiate before signing your option contract.
Deciding on a Purchase Price
While we mentioned earlier that it’s important to consider the price of a home before entering into a rent-to-own agreement, there’s a little more to it than that.
In many situations, the tenant and seller will set a specific price before signing the initial agreement. This can be a great way for the tenant to lock in their eventual purchase price.
Despite that, locked-in prices are usually somewhat higher, since sellers often want to be compensated in case the value of their home increases significantly during the rental period (and they’re stuck selling it to you at a lower price.)
In other cases, the tenant and seller will agree to determine a selling price at a specified date. This is often halfway through the rental contract period, or right before the contract period is over. That way, the price of the home will reflect its market value much more closely, and both sides will know they’re getting a fair deal.
The Risks and Downsides of Renting to Own
While rent-to-own options can be great for a particular type of buyer, they aren’t right for everyone, especially those who have very bad credit or little income. The main risk of renting to own is that you could wind up coming to the end of your option period and not being able to qualify for a home loan. This means that your option money, which could easily be $5,000 to $10,000, will have completely gone to waste.
Plus, if you signed a lease-purchase contract, instead of a lease-option contract, you could be legally obligated to purchase the property (even if you can’t obtain the loan you need); and the seller could take you to court.
Of course, renting to own also has all the same risks as regular home ownership -- and just because you’ve lived in the home for a while doesn’t mean you’re immune to unfortunate surprises. For example, if the owner owes back taxes or other assessments on the property, you could be required to pay them when you take ownership of the home.
For that reason, get a title search and title insurance on the property to make sure that the owner fully owns the home -- and that you will, too, when it’s yours. In addition, order a full home inspection before going through with the final purchase. The home could have structural issues or problems that you simply didn’t see during the time you rented it.
How to Make Sure You’re Ready for Rent to Own
Before signing a rent-to-own contract, take a careful look at your credit score, savings, and income in order to determine the actual likelihood of getting approved for a mortgage in time to buy the home.
To do this, contact reputable credit repair companies to see how long it will take for your credit score to rise above what you need to get approved. Create a budget to save for your down payment, and look into various kinds of loans, including conventional mortgages, FHA loans, and VA loans.
While doing so, take a careful look at the requirements for credit, debt-to-income (DTI), and down payment amount. That way, you’ll only pay your option money and get into the contract if you are certain you can get approved.
Renting to Own: In Review
Renting to own can be a fantastic option for some people, but it also has its fair share of risks. Unless you have good reason to believe that you’ll be approved for a mortgage by the end of the option period, renting to own can be a waste of money -- and might get you even further away from your dream of home ownership.
Also, the fact is that many rent-to-own contracts are lopsided in the owner’s favor. This may include significantly elevated fixed purchase prices and little to no rental or option money credits. In the end, rent-to-own isn’t entirely good or bad, you’ll simply need to take a hard look at your situation and contract to determine if renting to own is right for you.