Rent-to-own agreements offer a path toward home ownership for people who can’t qualify for a mortgage or afford a down payment. Under a rent-to-own agreement, you can move in and rent a home with the option of owning it later, often building a down payment as you pay rent. But keep in mind that this strategy can be risky.
Less-scrupulous sellers may take advantage of the fact that rent-to-own tenants may not have as many rights as homeowners. Depending on the terms of the agreement, the seller may have the right to evict a tenant, keep the money that was put toward the purchase and then rent the home out to a different tenant. Here’s what to know if you’re considering a rent-to-own agreement.
The Basics of Rent-to-Own Agreements
The details of rent-to-own, also known as lease-to-own, arrangements can vary greatly, as buyers and sellers may negotiate different terms, and standards or laws can depend on the area. Generally with rent-to-own agreements, the tenant pays the owner a deposit or monthly rent premiums, or both, with the intention of buying the home in the future. While some agreements offer the tenant an option to buy, others may require the tenant to buy at the end of the lease. And each agreement may have unique features.
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Some real estate agents may represent owners who offer rent-to-own agreements, or you might be able to search for rent-to-own homes directly available from landlords or property management companies. But keep in mind that the types and locations of available rent-to-own homes may not be as desirable as homes bought through more traditional means.
Important Terms to Know
As you evaluate different properties and agreements, make sure you understand how these terms come into play:
— Option fee: Some contracts require the renter to pay a nonrefundable deposit, also known as an option premium or option money, at the start of the lease. It could be a flat fee or a percentage of the home’s purchase price. Part, or all, of the fee could be applied to the down payment or purchase price of the home later.
— Rent premium: The rent premium, or rent credit, is the amount you pay in excess of the market rate rental price. For example, if the home would usually rent for $1,000 a month, your lease agreement may require you to pay $1,200 a month. The $200 rent premium is set aside in escrow and would go toward the purchase of the home later. However, if you don’t buy the home at the end of the lease, the seller may keep the premiums.
— Purchase price: The agreement may set a price that the renter can buy the house for. The tenant may be able to buy the home at any point during the lease. However, the contract may stipulate that the price increases each year. Some agreements stipulate the buyer will pay market value when executing his or her option to buy.
— Ongoing expenses: The contract will lay out whether the tenant or the seller must pay for maintenance, repairs, homeowners fees and property taxes during the lease.
Types of Rent-to-Own Agreements
An option-to-buy agreement, also known as a lease-option agreement, means that the tenant can choose to buy the home at the end of the lease or forfeit the accrued rent premiums and option fee. Judy Williams, a real estate agent with Halstead Property LLC in Manhattan, says it can look like a combination of a standard lease with the right to purchase the property at the end of the lease term.
During the lease term, the owner is typically not allowed to sell the home to anyone else, unless the renter breaks the lease. The tenant would still need to qualify for a mortgage and be able to afford the full payment when it’s time to close on the home.
Meanwhile, an obligation-to-buy agreement is more inflexible. Under this arrangement, the tenant agrees to buy the home at the end of the lease. If the tenant chooses not to buy the home or can’t qualify to buy it, he or she may face legal repercussions.
If you’re interested in a rent-to-own agreement, look for a lease-option agreement rather than an obligation-to-buy agreement, says John Michael Grafft, a real estate agent with Berkshire Hathaway HomeServices KoenigRubloff Realty Group in Chicago. “If you can’t buy it now, you may not be able to buy it later,” he says.
There are also less common rent-to-own agreements. Dustin Heiner, founder of Master Passive Income, a rental property investment blog and podcast, says he’s selling several homes in Ohio using a multiyear lease that allows his tenants to pay off the full value of the house over time.
It’s similar to how rent-to-own agreements can work with consumer purchases, such as furniture or appliances: The buyers give him a nonrefundable deposit and make rental payments for the lease term. “The renters do not have to get a loan or even qualify for one, but they will eventually own the home in the agreed-upon terms,” says Heiner. And, he’s happy to earn the extra rental income. In fact, he expects to earn a $60,000 profit from a rent-to-own property he originally was trying to sell for $9,000.
What Are the Pros and Cons for the Buyer in a Lease-Option Agreement?
Pros:
— If you found a home you want to buy, but need a few years to work on your credit or build up savings for a down payment, a rent-to-own agreement could lock in the property and price.
— Living in the home can help you better understand its quirks before you commit to buy. While you may lose your option fee and rent premiums if you back out, you generally aren’t required to buy the home.
— Your ability to back out could also be a good option if the home’s value decreases during the lease term and you choose not to buy the property.
— On the flip side, if the home’s value increases during the lease period, you can still purchase the home at the lower agreed-upon price.
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Cons:
— If you can’t qualify to buy the home at the end of the lease, you may lose your committed money and you won’t recoup any maintenance expenses you paid while living there.
— Your monthly expenses may increase if you have to pay market-rate rent plus a rent premium. By contrast, you may be able to simply rent a home and save what you would have paid in premiums for a down payment.
— Your lease could prevent you from keeping pets, subletting rooms or painting walls. If you violate the terms of the lease, you might be evicted, never get a chance to own the property and lose the money you’ve put in.
What Are the Pros and Cons for the Seller in a Lease-Option Agreement?
Pros:
— A rent-to-own agreement could be a good option for a seller who is having difficulty selling a home.
— The tenants will likely take good care of the home since they plan on owning it one day. Plus, the seller may not have to pay upkeep costs during the lease period.
— Even if the tenants back out of buying the house, the seller may be able to keep the option fee and rent premiums.
Cons:
— The seller may not be able sell the home until the lease period ends.
— If the home’s value increases, the seller still has to sell it for the lower agreed-upon price.
— Property taxes and home insurance are still your obligation as the owner, so you’ll need to verify that they are paid — even if the tenant is responsible for those expenses under your agreement, says Heiner. “If you leave the payment of the taxes to the tenant, then you must make sure and check with the local government to see if the taxes are paid,” says Heiner.
Get Professional Assistance Before Signing
There is a lot at stake when you’re considering a rent-to-own agreement. You may be making a multiyear commitment and promising to buy a home, which is the largest investment many people make.
Grafft says buyers should always use an attorney when considering a rent-to-own agreement. “All the terms must be negotiated up front,” he says. “The sales price, down payment, improvements and even potential rent increases should be memorialized before anything is finalized.”
Heiner says your attorney should verify that the agreement is enforceable and double-check whether there’s anything you should add or remove.
Before you sign the agreement, Heiner suggests verifying that the seller is the actual owner of the home, to avoid scams that involve people selling a home they don’t actually own. You may be able to go to the county recorder’s website or office and look up the property to find the owner of record. If a company is listed as the owner, do a little more research to make sure the person you’re working with owns or works with the company, advises Heiner.
[Read: The Best Bad Credit Loans of 2018.]
Tenants also should have the property inspected and appraised as buyers normally do prior to closing, says Williams. Otherwise, you may agree to a purchase price and give the seller a nonrefundable deposit only to find out the home needs tens of thousands of dollars of work.
Is It Worth It for the Tenant?
“For the sake of flexibility, I would simply suggest to do a lease agreement for the agreed-upon term,” says Williams. If you’re renting a home under a conventional lease agreement, you can still put in an offer to buy at the end of the term, or you can walk away without being concerned about forfeiting money. Renters without a rent-to-own agreement may be able to save up more money for a down payment than those who rent to own, as they generally don’t have to pay for repairs, fees or taxes like some rent-to-own tenants.
If you haven’t already, be sure to compare your options when buying a home. You may not need to put a lot of money down if you use an FHA loan, and some other conventional and government-secured mortgages are available with no money down. Government-backed programs may have less strict credit requirements than conventional mortgage loans.
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How Do Rent-to-Own Home Purchases Work? originally appeared on usnews.com
