Are Rent-to-Own Homes a Good Idea?
Few home buyers are able to purchase a home without going through the traditional route of securing a necessary mortgage. For first-time homebuyers, the process can be more difficult as lenders will want to see a solid credit history before issuing any loan. In most instances, all that exists is a rental history. For those with no credit, bad credit, or not enough saved for a down-payment, other alternative paths to home ownership become more appealing. One such alternative is what’s known as a rent-to-own.
A rent-to-own situation is an agreement that exists between a landlord and a renter (lessor/lessee) to enter into a contract for the purchase of a home at a future date that stipulates the right or obligation to buy. If a renter decides to move forward with this route, how does the process work? What are the associated risks?
The Process of Rent-to-Own
In a rent-to-own contract, the renter agrees to pay a one-time, nonrefundable fee also known as an “option fee”, usually between 2.5% and 7% of the purchase price. This is what gives the renter the option to buy after a set lease term.
The renter pays further monthly rent as they would under a standard lease, but a percentage can be negotiated and used as deposits toward the purchase price. The lessor can also charge a higher than market rent and apply the difference towards the purchase. Sometimes, no rent will be applied, and the renter can simply get the first right to purchase.
The additional part of the process is the option for the renter to purchase when they are ready or when the contract expires. It’s important to fully understand a contract as some come with a very-risky obligation to purchase, while others simply provide the option or right to buy.
The contract usually sets the price at current market value or higher to account for future market expectations. These can be structured by the lessors/landlords to include built-in increases for every year of a lease.
If the renter exercises the option to buy, they will still need to use traditional methods to secure a mortgage. Under a lease-option, the renter can still choose to walk away, though any money paid to that point will be forfeited. Lease-purchase contracts still stipulate the renter’s obligation to purchase, whether they can afford to or not.
Rent-to-own agreements can be ideal for those who want to move into a particular home but for various reasons, are not ready to purchase. However, they are not for everyone and potential candidates should do the necessary research to make sure such agreements make financial sense.