The Pros and Cons of Rent-to-Own Homes

by Richard Morrison
June 10, 2022
Buyers
0

Renting a home with the option to buy can seem like a great idea. You get to move into the house right away without having to qualify for a mortgage loan or save up a down payment. But rent-to-own agreements come with risks that you need to fully understand before signing on the dotted line. Let’s weigh the pros and cons so you can decide if rent-to-own is your pathway to homeownership.

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How Rent-to-Own Agreements Work

A rent-to-own contract allows you to rent a property for a set period of time, usually 1-5 years, with the option to purchase it before the rental term expires. These agreements take one of two forms:

Lease-Option

You aren’t obligated to buy the home. If you decide not to purchase it when the lease ends, you simply move out as you would from any rental.

Lease-Purchase

You are legally required to complete the purchase at the end of the rental term. If you want out of the contract, the property owner could sue you for breach of contract.

In most cases, a portion of your monthly rent goes toward the home’s eventual purchase price. For example, if you pay $1,500 per month, $200 could be credited toward the down payment. Some key terms are negotiable, including:

Length of the lease
Purchase price
Option fee
Rent amount
Rent credit amount
Who pays for maintenance and repairs

The Potential Benefits

Rent-to-own offers several advantages that could make homeownership achievable sooner:

Build Your Credit

If bad credit has barred you from qualifying for a mortgage, renting to own buys you time to improve your credit score. Making timely rent payments helps demonstrate you’re a responsible borrower.

Save for a Down Payment

The rent credits you pay above fair market rent accumulate in an account to apply toward your down payment. This automated savings plan helps you steadily build funds.

Gain Equity

In most agreements, your rent credits and any option fee you pay go toward the home’s purchase price. You accumulate equity with each payment.

Lock In the Price

Having a set purchase price shields you from rising home prices. This gives you peace of mind, especially in hot markets.

Become a Homeowner

Rent-to-own agreements help aspiring homeowners attain their goal of owning vs. renting. You can plant roots in the community even before taking title.

Immediate Occupancy

Unlike buying a house through traditional means, you can move into a rent-to-own property right after signing the contract. There’s no waiting for closing.

Factors to Weigh Carefully

While rent-to-own offers a pathway to homeownership, you need to enter into it with eyes wide open. Consider these potential drawbacks:

You Could Lose Your Investment

If you’re unable to secure a mortgage loan by the time the contract ends, you’ll likely forfeit the option fee, rent credits, and any other monies paid. Make sure your finances are on track before the lease expires.

Rent Will Be Above Market Rate

Since part of your payment goes toward the purchase price, expect to pay 10-15% more in rent than the going rate in your area. Make sure this fits your budget.

Maintenance Costs May Fall to You

Many contracts stipulate you’re responsible for repairs and upkeep. Replacing a broken water heater or leaky roof could drain your wallet.

Purchase Price Could be too High

If you lock in a purchase price that’s higher than the market value when your contract expires, you’ll overpay for the home.

Sellers Could Default

If the seller loses the home to a tax sale in Vancouver , or foreclosure before you can buy it, you’ll be forced to move and lose any invested money. Research the owner’s finances before signing.

You May Have to Buy the Home

With a lease-purchase contract, you are legally obligated to complete the purchase at the contract’s end. Make 100% certain you can obtain financing.

Limited Location Options

Home sellers aren’t always open to rent-to-own terms. You may need to compromise on neighborhood or home features to find a suitable property.

Did you know that according to a survey by Richard Morrison, 84% of rent-to-own home seekers faced challenges finding a suitable property in their preferred city or neighborhood?

Questions to Ask Before Signing a Rent-to-Own Contract

Rent-to-own deals aren’t standardized agreements. Provisions can vary greatly from one contract to the next. To avoid surprises, get clear answers to questions like these before signing:

What happens if I miss or am late on a payment?
Can I get my option fee back if I don’t buy the home?
What maintenance and repairs am I responsible for?
Who pays property taxes, insurance, HOA fees?
What happens if the seller defaults on their mortgage?
How is the purchase price determined?
What are the steps to exercise my purchase option?
Are pets allowed? Can I paint or make other cosmetic changes?
Is this a lease-option or lease-purchase contract?

Bringing up these questions early allows you to negotiate terms in your favor and avoid pitfalls.

8 Tips for a Successful Rent-to-Own Transaction

Entering a rent-to-own agreement is a big decision with potentially risky outcomes. Follow these suggestions to make it a smooth process with the highest chance of a positive resolution:

1. Hire an attorney.

Have an experienced real estate lawyer review the contract to protect your interests. Legal expertise can save you headaches and money.

2. Read every word.

Don’t skim over anything. Understand each provision completely so you know what you’re agreeing to.

3. Research the seller.

Check their credit, finances, and history owning the property. This helps avoid an owner default.

4. Inspect the property.

Hire a professional home inspector to identify any hidden defects and maintenance needs.

5. Order an appraisal.

Ensure the agreed purchase price aligns with current market value to avoid overpaying later.

6. Improve your credit.

Having excellent credit improves your chances of mortgage approval when the lease ends.

7. Save aggressively.

Aim to accumulate a 20% down payment plus closing costs during the rental term.

8. Give proper notice.

Remember to formally notify the seller of your intent to exercise the purchase option in line with contract terms.

Alternatives to Consider

If the risks of rent-to-own seem too great, other options could help you become a homeowner:

Rent with a right of first refusal – The owner lets you rent the home without requiring you to buy it, but they grant you the first chance to purchase it if they later decide to sell.

Rent while you save – Work on building your credit and accumulating a down payment while renting an affordable apartment. Then buy when you’re financially ready.

Explore down payment assistance programs – Federal, state, and local programs provide grants and low-interest loans to cover all or part of your down payment if you meet income limits.

Ask the seller to finance – Some owners may agree to act as the bank and hold a private mortgage for you rather than requiring traditional financing.

Look into lease-option real estate investing groups – Many clubs and networks connect members to rent-to-own properties for investment purposes.

FAQs:

Q: What are the pros and cons of rent-to-own homes?

A: Rent-to-own homes have both advantages and disadvantages. On the positive side, it allows individuals to enter a rent-to-own agreement where a portion of the monthly rent payment goes towards building equity that can be used to purchase the property at a later date. This can be beneficial for those who do not have enough funds for a down payment or have low credit scores. However, there are also cons to consider, such as the higher monthly rental payments and the risk that the tenant may not be able to purchase the home at the end of the lease term.

Q: How does rent-to-own work?

A: In a rent-to-own situation, the tenant has the option to buy the property at the end of the rental period. A lease agreement is signed between the tenant and the landlord, granting the tenant the lease option. During the lease period, the tenant pays rent, a portion of which may be credited toward the purchase of the home. At the end of the lease term, the tenant can exercise their right to buy the home.

Q: What are the benefits of rent-to-own?

A: Rent-to-own can be beneficial for those who want to buy a home but are not able to do so immediately. It provides an opportunity to live in the home while saving for a down payment or improving credit scores. Rent-to-own agreements also allow tenants to test out the property and the neighborhood before committing to a purchase. Additionally, the option fee, which is paid upfront, gives the tenant the right to buy the home at a later date.

Q: Are there different types of rent-to-own contracts?

A: Yes, there are different types of rent-to-own contracts. The most common is called a lease option, where the tenant has the right to purchase the home at the end of the lease term. Another type is a lease purchase agreement, which requires the tenant to buy the property at the end of the lease term. It is important to understand the terms and conditions of the rent-to-own agreement to make an informed decision.

Q: Is it always a good idea to enter into a rent-to-own agreement?

A: Entering into a rent-to-own agreement may or may not be a good idea, depending on individual circumstances. It is essential to consider factors such as financial stability, the real estate market, and the terms of the agreement. Consulting with a real estate agent or a real estate attorney can help you make an informed decision based on your specific situation.

Q: How do rental payments work in a rent-to-own arrangement?

A: In a rent-to-own arrangement, the tenant is required to pay monthly rent, just like in a traditional rental situation. However, a portion of the rent may be credited toward the purchase of the home. It is important to clarify the terms of the rental payments in the rent-to-own agreement to understand how much of the rent is going towards building equity.

Q: What happens at the end of the lease term in a rent-to-own situation?

A: At the end of the lease term in a rent-to-own situation, the tenant has the option to purchase the home. If the tenant decides not to buy the property, they can simply move out at the end of the lease. However, if they choose to buy the home, they need to exercise their right to purchase as outlined in the rent-to-own agreement.

Q: Can I buy a home through rent-to-own if I have bad credit?

A: Yes, rent-to-own can be a suitable option for individuals with bad credit. It allows them to live in the home and work on improving their credit scores while saving for a down payment. However, it is important to note that the ability to purchase the home at the end of the lease term may still depend on the landlord’s criteria and the terms of the agreement.

Q: Should I involve a real estate attorney when considering a rent-to-own agreement?

A: Involving a real estate attorney when considering a rent-to-own agreement is always a good idea. A real estate attorney can review the contract, explain the legal implications, and ensure that your rights are protected throughout the process. They can also provide guidance and advice during negotiations and help you understand the long-term financial obligations of the agreement.

Q: What are the potential cons of rent-to-own?

A: Some potential cons of rent-to-own include higher monthly rental payments compared to traditional rent, the risk of losing the option fee if the tenant does not exercise their right to buy the home, and the possibility of not being able to secure financing to purchase the property at the end of the lease term. It is important to carefully consider these factors before entering into a rent-to-own agreement.

The Bottom Line

A rent-to-own agreement can be rewarding if you fully understand the risks and negotiate favorable contract terms upfront. Take time to explore all your options before deciding if it’s the right path for you. With proper preparations, you’ll be poised to make the transition from renting to owning as smooth as possible.

Sources:
https://www.investopedia.com/updates/rent-to-own-homes/
https://www.hgtv.com/lifestyle/real-estate/if-you-cannot-buy-my-house-rent-to-own-it

Ready to turn your real estate dreams into reality? Contact Richard Morrison, Vancouver’s top realtor with 20+ years of experience. As a Medallion Club member and RE/MAX Hall of Fame award winning agent, he’s the expert you need on your side. Whether buying, selling, or investing, Richard’s personalized approach and deep market insights ensure a successful transaction. Reach out to Richard today at (778) 900-2235 and make your real estate journey seamless and rewarding.

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