If you’re in the market for a new property, chances are you’ll need to qualify for a mortgage. That can be far trickier than finding a home that you like — especially if you need to build or repair your credit. For this reason, you may be interested in a rent-to-own property.
With a rent-to-own contract, there is a two-step process: First, you’ll rent a house with a standard lease agreement for a period of time, with some of your monthly payment going toward an eventual down payment. Then, once the lease expires, you’ll have the option to purchase the property.
If you’re contemplating going through the rent-to-own process, you’ll need to tread carefully. There are a variety of pitfalls associated with rent-to-own agreements, including the risk of losing your down payment money if you aren’t prepared to finance the rest of the property once the lease ends. You also want to make sure you’re doing business with a reputable company or homeowner, rather than an unscrupulous seller.
Here’s a primer on how rent-to-own deals work and potential risks to be wary of before you commit.
[Read: Renting vs. Buying a Home: Which Is Smarter?]
How Does a Rent-to-Own Arrangement Work?
In a rent-to-own contract, typically individual homeowners enter an agreement with a real estate company for three years, with the option to extend a lease contract for four additional years.
“A rent-to-own contract will detail several things: your rent payment, (the) length of your lease, what you need to do to buy the home, the time you have to buy the home, how much you will pay for the home, potential rent credits and an option fee, which may be named something else,” says Misty Weaver, a realtor in Chantilly, Virginia.
The option fee, which is often between 2.5 percent and 7 percent of the purchase price of the home and is required before you move in, may be referred to as option money or option consideration. “An option fee is usually negotiated in order to show that you are serious about buying the home with a traditional loan within a certain number of years,” Weaver says.
Regardless of the number of years you’re planning to rent, part of your monthly payment (say, 20 percent) will go toward your down payment. And keep in mind, the rest of your monthly payment will likely be above the average rent in your market. After two or more years, you’ll have accrued the amount you’ll need for a down payment — or part of the necessary amount.
The principle with rent-to-own agreements is having at least some money put toward a down payment when the lease ends, with the goal of either paying the rest when the contract expires or extending the contract.
[Read: If You Can Afford to Buy a Home, Why Are You Still Renting?]
The Benefits of a Lease Option vs. Lease Purchase
You’ll want to be careful before signing a rent-to-own contract, and ideally have a real estate attorney involved and discuss any of the fine print. In fact, you should involve two lawyers, says Brenda Di Bari, a commercial broker with Halstead Real Estate in New York City. “It is crucial that an attorney prepare the contract and that the buyer have that contract reviewed by an independent attorney to be certain their interests are protected,” Di Bari says.
For instance, some of the things a contract should address is whether a renter is entering a lease-option or a lease-purchase agreement. With a lease-option contract, you don’t have to buy the house when the lease is up and you can walk away after the lease ends. But there is a snag: With a lease-option arrangement, you typically won’t get the money put toward a down payment back. Conversely, with a lease-purchase contract, at the end of the lease, you are legally obligated to buy the house.
Another thing to look for in the contract: if the option fee is included as part of the down payment. According to Weaver, many times the fee is not included.
Where to Find a Rent-to-Own Company
There are a number of rent-to-own companies that specialize in rent-to-own arrangements, including Home Partners of America, which has rent-to-own homes in 20 states, and Verbhouse, which covers homes in San Francisco. If you’re interested in purchasing a home with a rent-to-own contract, perhaps because you don’t have much money for a down payment or have shaky credit and want a few years to boost your finances, you should alert your real estate agent. It’s a common agreement for prospective homebuyers, and your agent may be able to find home sellers who are interested in doing a rent-to-own sale.
Do Your Research
Remember, the rent-to-own process can be fraught with peril. Di Bari points out that if you lose your job while renting your home and you can’t make a monthly payment, you could — if the contract is worded in the seller’s favor — lose the down payment money you’ve provided. You could even be evicted.
Think of it this way: If you have a good, well-paying job, but you haven’t raised the money for a down payment or you could use a few more years to build your credit, you may be an ideal candidate for a rent-to-own home agreement. And if you’re a prospective buyer looking to get approved for a mortgage in an expensive area and you want to bolster your credit by building equity, a rent-to-own agreement could be an ideal choice. But if you have poor credit and live paycheck to paycheck, a rent-to-own contract can be a risky proposition.
Other questions Di Bari suggests prospective homebuyers ask include: “What if the market dips and you’re locked into a purchase price that is no longer advantageous? Or (what if) the home will no longer appraise for a high enough amount to get your mortgage?”
[See: 10 Ways Millennials Are Changing Homebuying.]
Before you sign a rent-to-own contract, consider getting a home inspection and getting the house appraised. You should also make it clear in the contract that any property taxes due on the home while you’re renting are the responsibility of the owner.
Also keep in mind that the contract will need to indicate who is responsible for maintenance and repairs, Di Bari adds. That last point is important. After all, if you fix the plumbing and patch a hole in your roof while renting the property and things don’t go the way you plan, you may inadvertently be making your home nicer — for the next tenant.
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Rent-to-Own 101 originally appeared on usnews.com
