How Does Rent-to-Own Work?

How Does Rent-to-Own Work?

January 7, 2021
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How Does Rent-to-Own Work?

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It’s safe to say that if you asked 100 people if they would like to own their own home or prefer it to renting, 99 would say yes. Who wouldn’t want the freedom to decorate a home as they please and know that they have their money invested in an asset? Of course, for most, homeownership isn’t as simple as deciding to buy.

Unless you have a lot of cash or live in an extremely affordable area, there are many challenges to overcome when purchasing a home – the biggest being securing a mortgage. Mortgages can be difficult to get, especially if you are living paycheck-to-paycheck, and the penalties for not paying them back on time can be life-changing. A rent-to-own agreement is another route towards homeownership that may be worth exploring.

Today, we’ll explore how this differs, how it works, as well as the pros and cons of choosing a rent-to-own arrangement.

What is a Rent-To-Own Arrangement?

A Rent-to-Own agreement is essentially where you rent a home for a predetermined amount of time, and at the end of the lease agreement, you’ll have the option to buy the property, with a percentage of your monthly payment during the rental period used towards the purchase price.

How Does a Rent-to-Own Agreement Differ From a Normal Lease?

A rent-to-own agreement’s specifics can vary, depending on what the property owner and the prospective buyers negotiate within their agreement. The core differences are:

  • You’ll have an option to purchase the property at the end of the agreement
  • A percentage of your rent payment may be put toward the purchase price, which can replace the need for a down payment
  • You may be responsible for maintenance and repairs during the lease term

A rent-to-own agreement’s specifics can vary, depending on what the property owner and the prospective buyers negotiate within their agreement.

The Option to Purchase

This option to purchase usually comes with a one-time, non-refundable fee called the “option fee.” If you’ve ever heard about how film companies option books or scripts, this works the same way. Essentially you pay to retain the option to purchase the house, should you choose to. You will not be under any obligation to buy the property, and the seller will not be able to sell the property to anyone else within the agreed time frame.

The option money is negotiable, and there’s no standard rate. In most cases, it will be 1% - 5% of the overall sale price.

What is a Lease Purchase Agreement?

Pay close attention to the agreement type if you’re considering a rent-to-own agreement: a _lease option _agreement and a _lease-purchase _agreement are **not **the same. A lease option agreement is as we outlined above. However, a lease-purchase agreement means you are legally obligated to buy the house at the end of the agreement.

How Long is a Rent-to-Buy Agreement?

Again, this can vary significantly. It can be as little as a few months or as long as several years. It's something that you'll agree upon in your individual agreement.

How Do Rent-to-Buy Agreements Work?

To best explain, let’s imagine a scenario. Dakota and Taylor are walking through town one day when they spot a home they instantly fall in love with. It’s the right size for them, with a big yard, driveway, and looks well looked after. They find out that it’s on the market through rent-to-buy.

They contact the company organizing the agreement and view the home with a real estate agent. They adore it and are interested in moving forward since they have always wanted to own a home like this but haven’t yet been able to save a substantial down payment.

They start working with the company to outline the specifics of the contract. They negotiate and are able to secure the purchase price now.

What are the Pros and Cons (Benefits & Risks) of a Rent-to-Own Agreement?

Pros (Benefits)

  • It offers you the ability to buy a house you love without needing to find the money to rent and save for a substantial down payment at once, since a portion of your monthly rent will be put against the overall purchase price. A typical down payment can be between 10% and 20%, whereas the option fee is much lower (around 1% to 5%).

  • Your down payment money is put aside for you. Having a portion of your payments be set aside towards a "down payment" on the purchase price can be beneficial if you find you don’t save reliably.

  • You can fall in love with your house and know no one else will come in and take it. When you normally offer on a home, you are competing against other buyers. If someone wants to offer more than you or has the cash to buy now while you still need to secure your mortgage, you’ll likely lose it to them.

  • You can give yourself more time to build your credit score and get your ducks in a row for your mortgage. You know you want to buy a home, but you’re not ready yet on paper. Rent-to-own means you can start the process and make sure you’re in tip-top shape to qualify for a mortgage when the time to buy comes with it comes to your credit score and credit card debt.

Cons (Risks)

  • In a rent-to-own contract, you may secure the purchase price at the beginning of the contract or agree to determine it near the end of the agreement. Clearly, this leaves room for conflict, as the buyer may want more at the end of the contract than you bargained for, or if the market drops, you may end up paying more than you wanted. If you’re in a lease-option agreement, then you may be forced to walk away if you can’t agree on a price.

  • You’ll still pay rent, and it will be more than you would normally need to budget for since you’ll be paying toward the purchase price.

  • You will likely be responsible for some (or all) maintenance. Essentially, you’ll be responsible for the property before your name is on the deed. You need to carefully outline what you’re responsible for, and what the owner is responsible for, when you outline the contract. You may also be responsible for property taxes and HOA fees.

  • If you change your mind or if your life takes you elsewhere before you buy, you’ll lose your option fee. Like a film studio that options a book, if they don’t decide to use the book for material, they simply paid for nothing.

  • You still have to seek funding for the remaining house cost. You will still need to find funding for the house. If you're unable to secure a mortgage or loan, you will lose your money.

Clearly, a rent-to-own agreement is not something to enter into lightly. If you plan to do so, make sure you comb through your contract with the help of a real estate attorney and make sure it’s as favorable to you as possible. In many cases, the agreement will benefit the seller more than the buyer. This is understandable when they’re somewhat delaying the time before their equity is released, but you need to ensure you’re getting a good deal, too.

We’d all love to own our own home, but sometimes the timing just isn’t right. In many cases, the best thing to do is master your money and dedicate yourself to saving to purchase a property traditionally in the future.