When most people think about moving into a new home, they think of one of two options: owning and renting. Owning is cheaper in the long run and allows you to build equity in the property. Renting is more affordable in the short-term since you don’t have to pay a down payment, and you’re not responsible for maintenance. But what if you wanted to get the best of both worlds?
A rent-to-own house is precisely that. You don’t have to make a huge down payment, but you’ll eventually be able to hold title to the house. This can make it easier for first-time homebuyers to get out of an apartment and into a single-family home. What follows is a thorough guide on how to rent-to-own a house, including how to find an appropriate property.
What Are Rent-To-Own Homes?
In a traditional home purchase, the path is pretty straightforward. Purchasers first obtain a pre-approval from a bank, then submit a purchase offer. If the seller is agreeable, the purchaser then pays a down payment, and receives title to the home. The seller walks away with their home’s full value, and the buyer makes mortgage payments to the lender until it’s been paid off.
Renting to own cuts the bank out of the equation. Instead, the purchaser makes regular monthly payments directly to the seller. There’s no bank involved, so there’s no need to obtain pre-approval, and you don’t have to save up a hefty down payment.
In most rent-to-own agreements, the process starts with a lease that has a given term, sometimes more than three years. At the end of the lease term, the renter will then have the option to purchase the house outright. Or, they may be obligated to do so.
This is an important distinction. If the renter has an option, so they’re free to back out of the purchase. If they’re obligated to do so, they can face significant financial penalties for not following through.
[ Thinking about investing in real estate? Register to attend a FREE online real estate class and learn how to get started investing in real estate. ]
Types Of Rent-To-Own Contracts
The two main types of rent-to-own agreement are the lease option and the lease-purchase. The basic outlines of the two are the same: you lease a home for a few years, and you buy it at the end of the lease. That said, some significant differences are important to point out. Let’s go over the basics.
In a lease-option agreement, a portion of your rent goes towards your down payment should you choose to buy the home. The sale price is not negotiated in advance, and will be negotiated when the lease expires. If you decide to move forward – and the price is agreeable – you can usually qualify for a loan with no down payment.
Lease-option agreements also require you to pay something called an “option fee” when you sign the contract. This can range between 2% and 7% of the home’s appraised value. At the high end, that can be a significant sum. That said, the option fee will normally count towards the down payment, along with your rent credits.
If you decide not to go through with the purchase, you’ll forfeit your option fee, and you won’t get any reimbursement for your accrued rental credits. However, you won’t be liable for any additional charges, and your credit record will remain squeaky clean.
A lease-purchase agreement works a little bit differently. The broad strokes are similar; you still lease for a period of time before you buy, and a portion of your rent still counts towards a down payment. But you won’t have to pay any option fee upfront, just your first and last month’s rent and a security deposit. In exchange, you take on a legal obligation to purchase the house when the lease runs out.
Lily Wili from Ever Wallpaper advises “with this kind of rent-to-own agreement, you and the seller agree on a purchase price ahead of time, so you know whether or not you’ll be able to meet your obligations. You’ll also have the opportunity to shop around for mortgages well before the scheduled purchase date”.
If you don’t move forward with the sale, even if it’s because you can’t secure funding, you’ll lose credit for all of your rental payments. Not only that, but you’ll be in breach of contract, and the homeowner could sue you.
Lease-Option Vs. Lease-Purchase
So, which agreement is best for you? A lot depends on your financial situation. If you can’t afford to pay an option fee, you can get into a lease-purchase agreement much more quickly. Of course, that could come back to haunt you if you’re ultimately unable to secure mortgage financing.
According to Al Lijee from JunkGator another reason to consider a lease-purchase agreement is if home prices are rising in your area. By setting the price at the outset, you can end up paying less than you would if the value were set at the end of the lease.
With all of that being said, a lease-option agreement gives you the most flexibility and the least risk. If the option fee is reasonable, it’s a perfectly valid choice to make. Moreover, it can also work to your advantage if real estate prices are going down in your area. You could save a lot of money by setting the price at purchase time.
Pros & Cons Of Rent-To-Own Homes
If you want to get the most out of a rent-to-own arrangement, it helps to understand the pros and cons ahead of time. Why would you want to enter into this particular housing arrangement? Alternatively, why would you want to go a different route? Let’s talk a little bit about the upsides and downsides of renting to own.
Pros Of Rent-To-Own Homes
Easier financing – For many people, the hardest part of buying their first home is the down payment. By renting to own, your down payment will be significantly reduced, and could even be eliminated altogether.
The seller writes the contract – Traditional real-estate contracts are arranged by the lender. Lenders are experienced at this kind of thing, and will often draft deals that are very much slanted in their favor. Individual sellers are often less experienced, and may be willing to grant more favorable terms.
Less red tape – Since you’re not dealing with a bank at the time the lease is started, you don’t have to go through an approval process, wait for underwriting, and pray that nothing negative happens to your credit report. With a rent-to-own arrangement, the seller is the only person judging your qualifications.
You have time to save for a down payment – During the few years you lease your home, you’ll have the opportunity to put money aside for a down payment. To be fair, you’ll be paying a rental rate that’s higher than market value. But if you’ve still got a few extra dollars to spare, you can put it in a savings account, and you’ll have a little more cushion.
You’ll pay less for repairs – In most rent-to-own agreements, maintenance and repair costs are split between the buyer and the seller. If you buy a house the traditional way, you’re subject to repair costs right from day one. This can set you back thousands of dollars over a few years.
You’ll still have options – If you signed a lease-option agreement, you could just move out at the end of the term. This gives you flexibility you won’t have with a regular mortgage. If you’ve already taken out a loan, you’ll have to put the house on the market and wait for a seller before you can stop making payments.
Cons Of Rent-To-Own Homes
The market is much smaller – Not a lot of sellers are willing to sign a rent-to-own agreement. Traditional landlords typically have no interest in selling off their investment properties. Regular homeowners, meanwhile, normally want to close the sale as soon as possible, not after a few years.
The seller writes the contract – As we discussed, this can work to your advantage. But if the seller is savvy, they can craft a contract that’s designed to favor their interests.
You can lose money – When you rent to own, you pay an inflated rental fee, in anticipation that much of that will go towards a down payment. If you opt not to buy, you lose all that money. You’ll also lose your option fee, which can amount to thousands of dollars more.
It takes time – With a traditional purchase, you’re in sole possession of the property as soon as you close. With a rent-to-own agreement, you’re still a tenant for a while, sometimes for over three years.
You might be subject to liability – If you sign a lease-purchase agreement, you’re legally obligated to go through with the purchase. If you can’t obtain financing for some reason, you could be liable for damages.
How To Rent-To-Own a House
Renting to own is an uncommon arrangement, and it’s understandable that many people remain unfamiliar with the process. That said, it’s not terribly complicated. Here’s a quick overview of renting to own, from finding the right house to completing the deal.
Find The Right Property
Negotiate The Contract
Get A Home Inspection & Appraisal
Pay The Upfront Fee
Maintain The Rent-To-Own Home
1. Find The Right Property
As with any other home purchase, the first step is to identify the right property. However, this works a bit differently for rent-to-own homes than it does for traditional purchases. Many people choose to handle the process themselves when scouting for a new house. There are plenty of home listing sites out there, as well as local resources for prospective buyers.
Ryan Brown fromArt of Lock Picking advises that “unfortunately, most sellers have little interest in a rent-to-own arrangement. You can waste a lot of time and energy visiting potential sellers, only to find out that the deal is a non-starter for them”.
Instead, the best course of action is working with a real estate agent specializing in rent-to-own properties. These agents are intimately familiar with that particular market, and they can help you find the sellers you’re looking for. The right agent can also help you to convince a hesitant buyer to agree to a contract.
Of course, you don’t want to choose just any home. You want to look for the same things you’d otherwise look for. Do you like the neighborhood? How about the school district? Is it convenient for your commute? All of these factors will still be important when you’re selecting a property.
2. Negotiate The Contract
Once you’ve finally found an appropriate home, that’s only the first step. The next is to negotiate the rent-to-own contract. There are several possible issues that you and the seller will have to work out.
As part of this, it’s strongly advisable to retain a real estate lawyer with experience in rent-to-own contracts. This will cost you a little money in the short term, but it can save you a significant amount of cash and trouble down the road. The attorney can also make sure the contract is legally binding, so both parties can enforce it.
Different contracts will have different specific terms. That said, most of them will deal with the following things:
Option term – This is the duration of the lease period, after which the buyer will either complete the purchase or move out of the home.
Option fee – This is a pre-payment, equal to between 2% and 7% of the home’s appraised value. You’ll only encounter an option fee with a lease-option agreement.
Price – This is the price that the buyer agrees to pay for the home. According to James Brooks CEO of CostumesHeaven, this will typically be slightly higher than the home’s appraised value, to account for inflation. Normally, the price is only included in lease-purchase agreements.
Rent – The amount of rent that will be paid each month.
Credible rent – The portion of the monthly rent that will be credited towards the down payment.
Maintenance clause – The maintenance clause determines what portion of maintenance the buyer will be responsible for, as well as what the seller will pay.
Renewal clause – Some rent-to-own agreements give one or both parties the right to renew the lease at the end of the term, effectively putting off the final purchase date. This can help buyers to avoid liability if you can’t get financing at the end of a lease-purchase term.
3. Get a Home Inspection & Appraisal
As with any home purchase, you should do your due diligence before you put pen to paper. An important part of this is having the home inspected. Hire a licensed home inspector to thoroughly evaluate the home and identify any issues. It can also be useful to have the home inspected for pests, radon, and other potential issues. Along the same lines, remember to run a title search to ensure there aren’t any liens on the house or unpaid taxes.
According to Eugene Ladizinksy from Rollerup, it also doesn’t hurt to have a second inspection done before you make the final purchase. If new issues have arisen with the home, you may be able to negotiate a lower purchase price.
4. Pay the Upfront Fee
Assuming everything checks out with the home inspection, you’ll need to pay your option fee. This fee is normally non-refundable, and it’s designed to provide incentive for renters to complete the final purchase. It also gives the homeowner some compensation if the deal doesn’t go through. According to Yan Margulis from Capable Group Inc there’s typically no option fee on a lease-purchase agreement.
5. Pay Rent
Now that you’ve signed the agreement and paid your option fee, if applicable, you’re ready to move in. So move into the house, and start paying your rent. As long as you pay your rent on time, you’ll slowly accrue value towards the home’s down payment.
This is very important, because a single late payment could potentially void some rent-to-own contracts. Some unscrupulous landlords will take advantage for this, and create very long rent-to-own terms. Then, when someone is a few days late on a payment, after several years of renting, the landlord voids the contracts, and repeats it again with a new renter. Bottom line: be certain to pay your rent on time, every time.
6. Maintain The Rent-To-Own Home
Your rent-to-own contract will outline how much of the home’s maintenance you are responsible for. In most cases, the buyer will be responsible for small jobs, such as taking care of the yard and performing basic maintenance. Costs for larger repairs, such as roofing and HVAC systems, will typically be split.
How To Find Rent-To-Own Houses
As we talked about earlier, rent-to-own houses aren’t exactly the easiest to come by. It’s understandable that many sellers are hesitant, but even so, there are plenty of opportunities to come by. To find a rent-to-own home, you just need to follow the right process. The basic steps are as follows:
Talk To An Agent
Find Reluctant Landlords
Research The Foreclosure Market
Let’s take a closer look!
Talk To An Agent
A good agent can help you find more rent-to-own opportunities than you could find on your own. They know where to find the best listings, and can normally get you set up with some showings in no time. Agents can also explain the potential benefits of a rent-to-own deal to buyers who aren’t otherwise interested. This can get you access to a wider market than you’d otherwise be able to reach.
Once you’ve teamed up with a good agent, the next step is to talk with homeowners. Even if their listing doesn’t explicitly mention rent-to-own contracts, it might be able to talk them into it. If you like a particular property, it never hurts to put out an inquiry and see if the owner is interested. The worst thing they can say is “no.”
Find Reluctant Landlords
Along the same lines, it never hurts to talk to landlords who are offering rental properties. For most, their houses are a source of income, and they’re not really interested in selling. But some landlords get tired of the job, or simply have earned enough money that they’re considering retirement. According to Clive Whyte fromFreeInsulationScheme.org.uk a landlord who’s on the fence about staying a landlord may be willing to enter into a rent-to-own agreement. Once again, a good real estate agent can be helpful.
Research The Foreclosure Market
Homeowners who are under the threat of foreclosure are prime candidates to be rent-to-own sellers. The rental charges will more than cover their mortgage costs, with some money left over to get started elsewhere. Take the time to research your local foreclosure market, and see what’s available.
Renting to own is an excellent way to move into your first home. Without the need for a down payment, you can be living in a single-family home in no time at all. That said, it’s important to understand the different types of contracts, and all the ins and outs of the process to rent-to-own a house. That way, you can find the deal that works best for you.
Ready to start taking advantage of the current opportunities in the real estate market?
Click the banner below to take a 90-minute online training class and get started learning how to invest in today’s real estate market!