You find your dream home but there’s just one problem. You aren’t quite ready to purchase it but you don’t want to walk away, either. Maybe you don’t have enough saved for a down payment or can’t get approved for a mortgage because your credit score is in the trenches.
That’s where a rent-to-own agreement comes in. It’s a great way to get a feel for homeownership without taking the leap. And should the home not work out for you, there’s no obligation to stay put. You’re free to walk away once the agreement lapses with no strings attached.
Sounds like a rent-to-own home may be a good fit?
Read on to learn more about how they work, how much you can expect to pay, and how to find the best options on the market.
How Rent-to-Own Homes Work
When you enter into a traditional rental agreement for an apartment or home, you sign a lease agreement. It specifies the amount you’ll pay each month for the duration of the lease term. As a lessee, you’re also held to certain standards to ensure the property remains in stellar condition. But the landlord will make sure that any issues with the rental are addressed promptly as stated in the rental agreement at no additional cost to you.
You’ll do the same for a rent-to-own agreement, but there’s another component that gives you the option to purchase the home once the lease expires. This means you’ll get first dibs on the property so another interested party can’t outbid you should the owner decide to sell when your lease lapses. But while you’re in the home as a tenant, repairs and maintenance may be passed on to you, depending on the landlord.
How Much Do Rent-to-Own Homes Cost?
There are a few cost considerations to keep in mind when entering into a rent-to-own agreement. For starters, you’ll have a set monthly rental rate which is usually around the average for your market and could be negotiable, depending on the property type (i.e. apartment vs. single-family home) and landlord.
Also, you will be assessed an option fee, which grants you the right to purchase the home when your lease is up before it’s released to the general public (should the owner decide to sell). The fee is usually a few hundred dollars, but could be much more depending on the value of the home, and is also determined by the landlord.
And if the landlord is not willing to assume responsibility for minor repairs and maintenance, you should also factor in these costs when calculating your monthly cost commitment.
Scenario 1- Condo
- Monthly Rent: $1,600 for a two-year lease
- Purchase Price: $150,000
- Option Fee: 4%
- Anticipated Maintenance and Repairs: $1,000/annually (and you plan to buy so it’s more like renovation)
- Down Payment Savings: $1,536
Scenario 2- Town Home
- Monthly Rent: $1,700 for a two-year lease
- Purchase Price: $200,000
- Option Fee: 5%
- Anticipated Maintenance and Repairs: included
- Down Payment Savings: $2,040
Scenario 3- Single Family Home
- Monthly Rent: $2,000 for a two-year lease
- Purchase Price: $250,000
- Option Fee: 6%
- Anticipated Maintenance and Repairs: $1,500/annually
- Down Payment Savings: $2,880
Should You Enter Into a Rent-to-Own Deal?
It depends on your financial situation and homeownership goals. Some key benefits and drawbacks to consider:
What’s your motivation for entering into a rent-to-own deal? Is it due to cash flow issues that prohibit you from buying a home because you don’t have enough saved? Is your credit in shambles and you need time to build it up? Or are you worried about market fluctuations?
These are all valid reasons to consider a rent-to-own home. How so? Well, if your credit is an issue and you’re in the process of rebuilding, ask your landlord to report rent payments to the three credit bureaus. Assuming you make timely payments each month and don’t bail out on the lease before the term expires, your credit rating could improve.
If you’re fortunate enough to secure seller financing, you won’t have to jump through a bunch of hoops to get a mortgage loan. Reasoning: the home will be financed by the seller, which means you will pay them directly for the duration of the loan. But keep in mind that the loan term could be substantially shorter than average and require a balloon payment in the final month to wrap up the purchase and secure the deed.
But maybe your credit isn’t the issue, but your savings account is. As mentioned earlier, the aggregate total of the option fee that you’ll pay on top of the rent is usually allocated towards the down payment. So you’ll be boosting your down payment fund each month without much effort, which helps lighten the load when it’s time to seal the deal.
Assume you get a two-year rent-to0-own deal on a condo with a monthly rent of $1,000 and option fee of 5 percent that’s valued at $150,000. If you buy the condo using a mortgage that requires 3.5 percent down and the seller agrees to pay closing costs, you’ll only have to come out of pocket $4,050 ($5,250 – $1,200).
And if the future of the housing market seems so uncertain and you’re afraid to purchase out of fear that the market will plummet, a rent-to-own deal may be more ideal. If your predictions are right, you can walk away and find something at a more desirable price point when the lease is up. But if the market goes up, you won’t have to spend a fortune since the purchase price was set in stone when you signed the original agreement.
A Major Drawback
Unfortunately, there are a few drawbacks you should consider, like the higher monthly rent you’ll pay due to the option fee. It makes sense if you’re dead set on purchasing the home when the lease ends. But if you decide it’s not a good fit or can’t secure a mortgage when the time comes, you’ll lose your entire investment.
Also, keep in mind that rent-to-own agreements tend to span two years or more to give the tenant time to get their financial house in order so they can purchase the home. This means that the option fee can quickly add up and is money better spent working towards another financial goal, like paying off credit card debt, if you decide not to move forward with the purchase.
To illustrate, a home with a $325,000 purchase price is being rented for $2,500 per month with an option fee of 6 percent. If the lease term is 24 months and the tenant does not buy because they’re unable to come up with the downpayment or for some other reason, they will forfeit their investment of $3,600.
How to Find Rent-to-Own Homes
When you’re searching for the perfect home to rent or purchase, a quick online search in the desired area will suffice. But rent-to-own properties aren’t always as visible. You may have to ask around or consult with a realtor that specializes in these types of deals or search on Craigslist for opportunities.
If you’re currently renting, you can inquire with the landlord about the option to rent-to-own. You never know how they’ll respond, so it’s worth a shot. Also, be sure to express just how interested you are in purchasing the property for the right price so they’ll know you’re serious about making the home yours if the opportunity presents itself soon.
Another option: reach out to homeowners if their property has been listed for quite some time but remains unsold. There’s a possibility they’ll enter into a rent-to-own agreement if you’re serious about potentially purchasing their home.
A Viable Alternative
Ready to own your own home and would prefer to skip over rent-to-own homes? Consider a government-backed loan, like those offered by the Federal Housing Administration (FHA), United States Department of Agriculture (USDA), or Veteran’s Administration (VA).
And they’re ideal for consumers who are first-time homebuyers, have past credit challenges, or very little money saved to put down. Although you’ll have to pay mortgage insurance, they may be more ideal in the long-run as you have the option to refinance later on down the line when you’re in a better financial position.
Important Considerations for Sellers
If you’re on the other end of the equation as a seller, there are some benefits and drawbacks to consider.
Having a rent-to-own tenant usually means the property will be well-maintained. Since they’re paying a premium to occupy the property, they’ll more than likely keep it in tip-top shape since it may someday be their own. And if the seller does walk, you’ll pocket the monthly fees they paid for the option to purchase.
But if the market does explore and they decide to purchase, you could lose a nice sum of dough because you’re legally obligated to sell them the home if they can secure financing.
The Bottom Line
A rent-to-own home may be the perfect opportunity if you intend to buy a home but need time to sort out credit issues and save up for a down payment to have the best shot at being approved. But if you’re still uncertain about homeownership, it’s more practical to enter into a traditional lease agreement until you’re clear on your financial goals to keep more of your hard-earned money in your pocket.