The American Dream is to own a home. For many people, their credit rating is keeping them from reaching this dream. To make matters worse, banks tightened up on their lending requirements after the Financial Crash of 2008. That has kept many first-time home buyers out of the market.
Rent to own homes also called lease to own homes, have risen in popularity over the years. Under this program, a person enters into an agreement to rent a home, with an option to buy it at a later date. These contracts typically cover a period of two or three years. This allows a renter time to fix their credit in order to qualify for a mortgage. At the end of the contract, the renter can either move forward with the purchase of the home or not.
While this sounds like a relatively simple process, renters should have a good understanding of how rent to own home agreement works. Read on to learn more about renting to own a home.
How Does Rent to Own a Home Work?
A rent to own home arrangement will involve several different concepts As such, you need to understand how they work. These include;
Rental agreement – The rent to own home arrangement starts with a rental agreement. This agreement will be different than a typical rental agreement that you would have with a landlord. Key differences include:
- Maintenance costs – When you rent a home or apartment, the landlord is typically responsible for the cost of maintaining the property. Under a rent to own agreement, you will take on more responsibility for the upkeep as it is expected that you will be purchasing the home.
- General rules – As a renter, you will be required to follow the rules that the landlord defines. This may include no pets or smoking in the home. If you violate these rules, it could void your agreement.
Lease option to buy – This stipulation gives you the option to buy the home after a certain period of time. The purchase price is an agreed-upon amount. When you enter into a rent to own agreement, you will be required to pay a non-refundable option fee. This secures your ability to purchase the home in the future. This option fee typically ranges from 2% - 7.5% of the purchase price of the home.
If you move forward with purchasing the home, the option fee is typically credited toward the purchase price of the home or toward closing costs. If you don’t buy the home, you will lose the option fee as it is non-refundable.
Rent payments – Under a rent to own agreement, a portion of your rent payment will go toward the purchase price of the home. Therefore, monthly payments under a rent to own arrangement will be higher since it includes the additional amount. This is typically something that you negotiate with the landlord. The amount that you pay in each month toward the purchase price is also nonrefundable. If you decide not to buy the house, you will lose this amount.
Let’s look at an example: Joe and Sara enter into a rent to own agreement that lasts two years. They agree to purchase the home for $180,000. The lease option fee is 2% of the purchase price, or $3,600. Their monthly payment is $1,650, which includes $1,500 in rent and $150 toward the purchase price.
When they sign the rent to own agreement, they will be required to pay a $3,600 option fee. During the term of the agreement, they will make 24 payments of $150 toward the purchase price of the house, which totals $3,600.
- If they purchase the home, they will receive credit for $7,200. This will reduce the $180,000 purchase price to $172,800.
- If they decide not to purchase the home, they will lose $7,200.
Avoid the Pitfalls of Rent to Own a Home Agreements
Rent to own agreements can be highly beneficial to some people. These agreements should not be taken lightly as they are legally binding documents. It is important that you understand a few things:
- Any money that you pay in as an option fee or toward the purchase price each month will be forfeited if you decide not to buy the home or are unable to. Before you enter into an agreement, you should speak with your potential lender to find out if you are able to obtain a mortgage at the end of the agreement. If your credit isn’t high enough by the end of the term, you may be out of luck.
- Know the difference between a lease option and a lease purchase. A lease option gives you the choice to purchase the home, but you aren’t obligated to do so. A lease purchase, on the other hand, legally requires you to buy the home. A seller could pursue legal action against you if you don’t purchase the house.
- Get a professional home inspection done before you sign the agreement. If the house needs significant repairs, you want to know this going into the agreement as this may fall on your shoulders at some point. You may also want to negotiate the purchase price.
- Know the market – Be sure to do your homework around the purchase price of the home. If the market prices fall during your rental period or if the house is overpriced, you may be paying more for a house than what it’s worth.
- Make sure the landlord is in good standing with the property. A title search will verify that the landlord legally owns the property. Inquire about the status of the mortgage payments and if they are current. If the landlord falls behind or does not own the property, you could lose out on any money that you’ve paid in toward the option fee and the purchase price.
Should I Rent to Own a Home?
If you’ve found the home that you want to live in, but don’t have good enough credit to get a mortgage, then the rent to own scenario may be a good option for you. It gives you a few years to fix the blemishes on your credit, which should help you to get a mortgage and a good interest rate. It can also give you the ability to lock in the purchase price of a home now, which can save you money if the market prices rise over the next two years. Finally, it gives you the ability to test out the home and neighborhood to make sure they are a good fit. If they aren’t, you will lose what you’ve paid in. However, you won’t be committed to a mortgage on a home that you don’t like.