Rent To Own: What Is It and How Does It Work?
Credit problems and the inability to save up a down payment top the list of things that keep people from buying a home. Renting to own eliminates both obstacles, but it can be a risky transaction for the tenant. Find out what rent to own is, how it works — and whether it’s a realistic path to homeownership.
What Is Rent To Own?
Rent to own is a transaction where a tenant and property owner enter into a several-year lease with the understanding that the tenant wishes to purchase the home at a later date. In the meantime, the tenant pays an option fee for the right to purchase the home later, and they make small payments toward their eventual down payment along with their regular rent payments. The tenant might also be responsible for home maintenance and repairs.
If things go as planned and the tenant buys the house at the end of the lease term, the property owner will credit them for the payments they made during the lease term.
How Does Rent To Own Work?
Rent to own is like two transactions in one — a lease and a sales agreement. How it works depends on the type of you have.
As the name suggests, a lease option lets you choose whether or not you buy the property at the end of the option period. A lease purchase, on the other hand, obligates you to purchase it.
Here’s what is usually included in both rent-to-own lease types:
- Lease (option) term
- Rent amount
- Option fee
- Purchase prepayment amount to be paid with rent
- Responsibility for maintenance and repairs
- Purchase price
- Provisions for return or forfeiture of monies paid in the event the tenant doesn’t purchase the home
Although rent-to-own agreements pose benefits and risks to both parties, the tenant bears a disproportionate level of risk.
Good To Know
Tenants should have an attorney review their lease option or lease purchase agreement before they sign.
What Are the Benefits of Rent To Own?
Tenants sometimes look for rent-to-own properties when they want to buy but don’t qualify for a mortgage, usually because they’ve been unable to save enough cash or they’ve had credit problems. The option term gives them time to get their finances on track so that they’ll qualify for a mortgage loan once the lease ends.
For property owners, rent to own is a low-risk transaction. For one, the long option term means they don’t have to worry about potential vacancies each year, which costs them money in lost rent and the work involved in finding a new tenant. In the event the rent-to-own tenant stops paying rent, the property owner has the option fee to offset their losses. In the meantime, the tenant likely has been responsible for upkeep on the property owner’s home.
What Are the Risks of Rent To Own?
The primary risk to the tenant is that they won’t qualify for a mortgage after the lease ends. In the case of a lease option, their losses are limited to forfeiture of the option fee, the payments toward the down payment and any money they invested in maintenance and repairs. The losses could put them even further from buying a home than if they’d just rented. But in the end, it’s no harm, no foul because the tenant had no obligation to purchase.
Not so with a lease purchase. In addition to losing the option fee, purchase payments and maintenance and repair costs, the tenant could be liable for losses suffered by the property owner as a result of the tenant failing to follow through with their purchase obligation.
Even if all goes well and the tenant proceeds with the purchase, it’s possible that the home will have lost value since the agreement was signed. If this happens, the tenant would need enough cash to cover the difference, as a mortgage lender won’t finance more than a home is worth.
The property owner’s most significant risk is that the property with appreciate more than anticipated during the option period, meaning they would have sold the home for less than its market value. But again, the property owner’s losses are offset by the option fee.
How Can I Reduce My Risk?
The best way to reduce your risk is to insist on an attorney review of your rent-to-own contract. Other steps you can take before signing the agreement include the following:
- Work with a buyer’s agent to help you negotiate the deal.
- Have the property inspected by a licensed home inspector, and then negotiate owner-paid home improvements and repairs as a prerequisite to signing the lease.
- Get an appraisal to make sure the purchase price you agree to is consistent with the home’s value.
- Work with a credit counselor or mortgage lender to improve your credit during the lease term to increase your chances of qualifying for a mortgage by end of the lease.
Are There Alternatives to Rent To Own?
A right of first refusal provides the primary benefits of renting to own with none of the risk. With this arrangement, you and the property owner agree that in the event the owner sells the home, you’ll have the opportunity to purchase under the owner’s preferred terms before the owner accepts an offer from anyone else.
Rather than pay the property owner an option fee and advance payments toward the purchase, you sock that money away in your own account and let it build while you improve your credit. This way, you don’t maintain a property you don’t own, and you don’t risk your own funds in the event you can’t or don’t want to buy the house or condo when the owner is ready to sell.
Keep in Mind
An owner advertising rent to own probably won’t agree to doing a first right of refusal instead because the refusal has none of the seller’s benefits of rent to own. And you’re unlikely to find a property owner actively looking for a tenant who might buy the home after renting for a couple of years. But by asking the right questions when you start looking at rental properties, you might find an owner planning to sell in the next couple of years who’d agree to this arrangement in exchange for getting a long-term tenant and perhaps a quick sale.
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- International Association of Certified Home Inspectors. "Rent-to-Own Home Leases."
- Realtor.com. 2020. "What Is a Right of First Refusal in Real Estate? Getting First Dibs on Making an Offer."