Rent to Own: How Does It Work?
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Rent to own creates an opportunity for renters to save for a down payment as part of their monthly rent.
It can be a good option if you really love the house or condo you're renting and would like to stay there for years to come. If you've recently struggled with credit issues, rent-to-own can also grant you a few years to build back your credit score as you save for that down payment.
How can I find a rent-to-own home?
Rent-to-own is less common than regular home sale listings, so you may have to do some research before finding some options.
They're usually found in one of three scenarios:
▪︎ If a home has been on the market for a long time with no prospective sales, the seller may want to offer a rent-to-own option.
▪︎ If a property owner who already has renters wants to put the home on the market and the renters want to buy it, they might request a rent-to-own arrangement.
▪︎ If you notice a home has been on the market a long time and you're not quite ready to buy, you can ask the seller if they might be interested in a rent-to-own scenario.
A portion of rent for a down payment
You might sign a rent-to-own contract with a private owner or a developer that manages many rental properties. In either case, your rent will likely be higher than the market rate since a portion of your monthly payment will be going towards saving for a down payment. The payoff is that you'll be paying towards equity in the home in the form of a down payment.
For example, you might sign a rent-to-own lease at $2,000 per month with $350 of that amount going towards a down payment. Over three years you'd save $12,600 for the down payment, which would be 3.6% percent of a $350,000 purchase price.
With a 3.6% down payment, you could qualify for an FHA loan, which is a type of loan insured by the Federal Housing Administration. The minimum down payment for and FHA loan is 3.5%. Read more about how these and other types of mortgage loans work.
Types of rent-to-own contracts
There's no industry standard rent-to-own contract, so it's a good idea to have a lawyer review the lease before you sign. You'll want to make sure you know where the down payment funds are being held, the length of the contract, who will be responsible for maintenance and repair obligations during the rent-to-own period, as well as any tax implications or other regulations in your state. In some states, rent-to-own contracts must include property disclosures just like a conventional home sale.
Option to buy
Some contracts give you the option to buy the home at the end of the contract. If at the end of the lease you decide you don't want to buy, you can get out of the contract but you will likely lose the money you paid towards the down payment.
Agreement to buy
Some contracts legally require that you purchase the home at the end of the lease. This is also known as a lease purchase, and with this type of agreement you typically become an owner of the home when you and the landlord sign the lease. You and the landlord would go to the county and place your name on the lease along with the current owner's. When the lease term ends, since you're already an owner of the home, you would "refinance" rather than open a new mortgage loan. And this might mean you get better loan terms, including a lower interest rate.
A purchase lease is a more secure way to go. For example, the seller can't take out a loan on the home. Or, if the landlord passes away before the contract is up, the family can't cancel the agreement. But it also means you need to be certain you can afford to buy the home—you may even want to get pre-approved for a loan so you're ready when the time comes. Otherwise you could end up in court. Since you'll be legally on the hook to buy, be sure to do your due diligence regarding inspections and making sure you'll want to stay in the home for years to come.
You'll negotiate the price with the property owner directly in most cases. Real estate agents aren't usually involved in a rent-to-own agreement, so you'll need to do your own research on comparable home prices in the area. When the lease period is over, you'll apply for a mortgage just like any other home buyer. Read more ORO articles to learn about types of home loans , types of loan officers, how to prepare for the costs of buying a home, and lots more information on how to prepare for homeownership.
Sources: Trulia, Zillow, Nolo
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