What is Rent-to-Own?
Sometimes you are faced with a situation where you want to buy a home but you either have a low credit score or you don’t have enough money to put for down payment that prevent you from buying. But there is an alternative if you still want to explore the possibility of buying a home.
Rent-to-own (also known as lease option or lease purchase) is a lease agreement that offers tenant an option to purchase the property when or before the lease expires. This agreement provides an opportunity for aspiring homeowners with no down payment to build up a down payment while enjoying the comforts of living in the property they could completely own in the future.
Often people confuse the lease-option and lease-purchase contracts. Although they serve the same purpose, there’s a difference between the two. A lease-option is an agreement that provides the tenant with the option to purchase the property at a set price any time before the lease is over. A lease-purchase on the other hand is an agreement with a sale contract attached to it. Unlike lease-option, the property requires purchase by the end of the lease period.
Truly rent-to-own home may be a good choice for someone looking to buy a home but it also imposes significant risks.
How Does Rent-to-Own Work?
In a rent-to-own agreement, you’ll have to pay the seller a one-time non-refundable fee to be given the option to buy the home at a later date at an agreed price. The option money is negotiable and can range from 2% to 7% of the purchase price.
Depending on your negotiation with the seller, you could agree on a fixed purchase price (often higher than the current market value of the home) when you sign the contract or agree to determine the purchase price based on the market value when the lease expires.
The lease term is negotiable but typically ranges between one to three years. During the lease term, you’ll pay a specified monthly rent that’s usually higher than the normal ‘going rate’. A percentage of this is credited to the purchase price.
Depending on your agreement with the seller, the seller or you will be responsible for the home maintenance and repair. Be sure it is specified in the contract.
No two contracts are alike; some contracts give potential buyer the right to buy but not the obligation to buy the property when the lease expires. It is important that you fully understand the stipulations of the contract before agreeing to it.
If in the end of the lease term you decide not to purchase the home or if you are unable to secure financing, you forfeit all the money you paid for the home. If you are able to get financing, based on the terms of your contract, a percentage of the rent paid and option money may be deducted from the purchase price. And once the transaction is completed you become the new homeowner.
Pitfalls of Rent-to-Own Homes
While the concept of rent-to-own looks promising for aspiring homeowners, the actual practice has significant pitfalls that potential buyers should be aware of. It’s vital to read and understand every word of the contract with the help of a real estate attorney or a trusted buyer’s agent so you know exactly what you’re getting into.
Lack of Security
Should you default on the rent payments, if stipulated on the agreement, you will lose your option to buy the home and lose everything you have paid to date. If this happens, you have no legal option to recuperate your investment regardless of how close to the end of the lease term you may be.
Also, if the landlord/seller defaults on his mortgage, the home may end up in foreclosure and you have no legal option to get back all your investments.
Unable To Get Financing Later On
If you still cannot secure financing or your credit rating is still insufficient for mortgage consideration, you will lose the money you already invested in the property. Also, one thing to look into if you are getting finance through conventional lender, the lender won’t recognize the percentage of your rent payment as part of the down payment. Often, you will still need to have enough cash to pay for down payment.
Falling Home Prices
If the market declines, you will still have to pay the higher price stipulated in the lease-purchase contract. In a lease-option agreement, you can sometimes renegotiate with the seller but if renegotiating is impossible, you’ll have to decide whether it’s wiser to walk away or go through with the deal.
Scams to Watch Out
Some unscrupulous owners who are going through foreclosures offer rent-to-own deals to unsuspecting renters. After taking the inflated rent payments and option money even though they are in foreclosure, renters are left with eviction notices when the home is repossessed by the bank.
The Seller Can Refuse To Sell
A seller may also try to back out the contract if the market is good and property’s value has significantly increased. This action is of course illegal but if you don’t have the financial resources to hire a lawyer, there’s not much left to do.
These are some of the risks you have to watch out for if you are going to a rent-to-own arrangement. Rent-to-own is a good idea if the agreement is between a trustworthy seller and a sensible and responsible buyer. It is an excellent option with good advantages if you do your homework well and understand how rent-to-own homes work.