You may or may not have heard of rent-to-own homes before. If you haven’t, then you’re about to learn everything you need to know about them. If you have and are trying to decide whether they’re a good idea, let us help you out in this guide.
Rent-to-own homes work similarly to a car lease. You pay a set amount each month to live in the home and then at the end of a set period, you have the option to purchase the home.
This period is typically around three years.
A portion of the rent paid each month will go towards a down-payment for the home. At the end of the period, that portion of the rent will be deducted from the selling price.
Rent-to-own homes can be a good option for both sellers and buyers, depending on the scenario.
Sellers who are having trouble selling their home and want to move into their new home ASAP might consider this option. Who can really afford two mortgages? Not many people. Buyers who are having trouble getting a traditional loan or need time to build up their credit might also consider this.
Either way, both parties need to negotiate and be very transparent on the terms before signing any type of contract. In fact, it’s almost necessary for each party to have some sort of real estate lawyer to help negotiate the contracts and to help make sure each party is 100% clear as to what’s going on.
Other Important Things to Know
Sounds simple, right? Before we get into exactly how this type of deal might benefit the seller/buyer, let’s go over a few more facts.
- The future sale price of the house is locked in for the entire duration, no matter how much house prices fluctuate during this time. Of course, depending on the market, this could work in either the buyer’s or the seller’s favor.
- In addition to a rent premium, buyers must also pay an option fee. This is something the renter pays the seller and if at the end they decide to buy the house, it becomes part of the down payment.
- If, however, they ultimately decide to not buy the house, it will go straight to the seller as income. Same goes for that rent premium.
- Again, this can be good for sellers because they earn that money regardless! If the renter decides to buy the house, great! Their house is sold. If they don’t, annoying, but at least they receive a significant fee for their trouble.
To make things even more concrete, let’s go over an example.
Let’s say that a house costs $400,000. A typical down payment of 20% would be $80,000. That’s a pretty big chunk of change! In a rent-to-own scenario, things are different however.
Now let’s say that typical rent would be $2000 for a home of this price. The buyer would pay $2400 instead. The extra $400 would be a rent credit and will go towards the future down payment of the home.
The buyer would also have to pay a $10,000 option fee that will go towards the value of the house. All in all, over three years, that would be $24,400 taken off the value of the house! By now, hopefully your credit is better or you’ve saved up more money for a down payment.
Remember – every aspect of this deal is negotiable. This includes the option fee, rent credit, price of the house, how the rent credit is applied (home value or down payment), etc. This is why it’s important to have a knowledgeable real estate lawyer.
Why is it Good for Buyers?
- The primary reason that a buyer would want this option is so they can save up the money for a down payment or repair their credit to get a good loan rate.
- Another overlooked reason is if you think home values are going to rise significantly in the next few years. This is a great way to lock in a much lower price.
- Renters/buyers are also able to walk away if they find any serious defects on the house. It is true that you would lose the rent premium and option fee, but isn’t that better than buying a house with major problems? It could be!
Why is it Bad for Buyers?
- At the end of the day, you’re still going to have to come up with a good amount of money for the option fee. If you can afford this, might it not be smarter to maybe invest this money? Or maybe just wait a couple more years and save up some more.
- With most agreements, you forfeit that month’s rent premium if you’re even one day late on rent. One time might not be a big deal but if this happens a few times, it can significantly reduce the benefit that you’re getting from this agreement.
- This next one is a big one. If for some reason, the seller fails to pay the original mortgage on the house you’re living in, it could go into foreclosure. This means you would literally have to move out and might have trouble getting your rent premiums and option fee back.
- At the end of this whole process, if you still can’t get a home loan or are not in a position to buy, you just wasted three years and thousands of dollars on the rent premiums and option fee.
- While you may technically be a tenant, often times the renter/buyer is still responsible for any repairs or any other issues around the house. Cleaning a septic tank might be included in your responsibilities, check out our guide right here if you want to get a better estimation of the costs involved.
Why is it Good for Sellers?
- If home values are going down, you can lock in a decent selling price for the future.
- The renters generally have to take care of any repairs/issues even during the rental period.
- If the renter still can’t buy, you get to keep all the excess money!
Why is it Bad for Sellers?
- If a potential new buyer suddenly comes along and wants to purchase the house immediately or at a higher price, there’s nothing you can do. You have to honor the contract.
- If the renter does back out at the end, you do get to keep the money, but now you still have to sell your house! Annoying if you just want to be done with your house.
Because of all of these complicated risk factors, it’s almost 100% necessary for each party to consult with a qualified real estate attorney.
All in All?
With all that being said, rent-to-own scenarios shouldn’t really be your first option. It’s mainly an agreement born out of necessity for one or both parties. In any scenario, both parties are extremely vulnerable.
This can be an ideal scenario if the other party is someone you trust. Perhaps a family member or best friend that you just want to help out.
If you want our recommendation (and in most cases, the recommendation of other people) – if you can wait it out, just wait it out.
As a buyer, just save up a little bit more money and don’t be so eager to jump right into such a big decision.
If you do decide to go with it, make sure you’re smart, negotiate a good contract, and know what you’re getting yourself into. If you’re having a problem with soap scum with your stay, read our guide on how to remove soap scum from glass.