Most people know that rent-to-own is a thing… And that’s about all they know about it unless they’ve been directly involved in a contractual agreement regarding a rent-to-own house. There are many scenarios where one of these agreements benefits both parties, but it’s very important that all parties, especially the purchaser, know the risks involved.
Primary beneficiaries of these agreements tend to be first-time homebuyers who need some more time to build up their credit or save money for that juicy downpayment. This article will aim to educate you on all parts of a rent-to-own house agreement, when they are appropriate, and when you should probably think about going a different route.
Table of Contents
Two types of rent-to-own house agreements
There are some stipulations within each arm of the rent-to-own tree, but lease-purchase agreements and lease-option agreements are the two major types of contracts used when discussing rent-to-own business agreements. Here’s a closer look.
A lease-purchase agreement involves commitment from both parties, whereas the lease-option agreement does not. In a lease-purchase agreement, the owner of the home enters a contract with a renter who pays rent plus an additional option fee. Generally this fee also goes towards a downpayment.
The two parties also discuss what the final selling price will be at the end of the lease term, and so long as a mortgage is secured by the renter/buyer, the two parties enter into the sale.
On the other hand, lease-option agreements also include a fee that can ultimately go towards a downpayment on the home, but the only sales promise is that the landlord will offer the home to the renting party before they offer it to anyone else.
This puts less pressure on a renter/buyer who may have fluctuating income and is afraid of an inability to secure a mortgage, and it also allows owners to raise their sales price if the original renters do not want to purchase. Sellers must sell to the renters for the agreed-upon price, regardless of appreciation.
Here are a few aspects of rent-to-own agreements and the industry norms relative to each.
In most cases, maintenance costs are covered by the owners until the house has been purchased after the agreed-upon lease period. This must be contractually agreed upon, however, and there is always some grey area. A thorough inspection is highly recommended before entering into a rent-to-own agreement.
Property taxes are also generally paid by the owner until the point of sale following the rental period.
As the name would suggest, homeowners insurance is also the responsibility of the owner, though it certainly is in the best interest of the buyer to check and make sure the property is well-covered.
Many parts of a rent-to-own agreement are very similar to a renter/landlord agreement prior to the point of sale, but the lease period tends to be much longer, and three years is a typical length.
Down payment building
Another contractual regularity on a rent-to-own agreement is how much of the buyer’s monthly rent will go towards the down payment. In most cases, 20% is commonplace. For instance, if a house is rented for $3,000 per month, $600 will go toward an eventual downpayment after the lease period. If the agreed-upon lease period is 3 years, then in this scenario, a down payment of $21,600 can be used by the renter or buyers, which is a value you can obtain by multiplying 36 months by $600 per month.
Additional contractual norms
The contract of sale will include an agreed-upon price that the home will be sold for following the lease period. Generally, this is higher than market value, due to the appreciation of homes. It is also important to include a nullification clause if you’re the buyer, in a situation where you’re unable to secure funding, or you can be held responsible for the purchase even if you don’t have any financing.
Benefits for the buyers
Like any sensible business agreement, there are benefits of rent-to-own properties for both parties, given they are in the correct situation. Here is a look at some benefits the renters/potential buyers have when entering into a rent-to-own contract.
If a potential buyer is concerned about their credit hindering a mortgage, a rent-to-own gives them a few more years to strengthen that credit before looking to secure home financing.
There are accelerated family plans designed for families who may need a bigger home, and a rent-to-own agreement can put in you a potentially lifetime home while giving you a few more years before you have to make the financial commitment that comes with it.
Save for a down payment
In both types of rent-to-own contracts, a portion of the monthly rent is allotted to a future down payment that will be used at time of purchase. In other words, it’s an easy way to stay disciplined when saving for a down payment.
Though it is normal for parties to agree on a purchasing price higher than the market value since the house won’t actually be purchased for 3 or 4 years from now, more often than not, appreciation will lead to the home being worth more than it was paid for on the day the renter or buyers become the owners.
Benefits for sellers
Sellers in certain situations can benefit from these agreements as well. Here are some ways that happen:
Simply by offering a rent-to-own option, your potential buyer pool grows immensely. As mentioned many times, many rent-to-own buyers are people who aren’t financially prepared for any other options relative to homeownership.
Potential for bonus money
The agreed-upon option fee that tenants pay will go towards a downpayment if they decide to buy the property. If they do not, that money stays with the seller and could go a long way with making the home more appealing to the next potential buyers.
If someone is a real estate whiz, locking in a price 3 years before a sale can result in a lot of money being saved in a case where the home actually loses value during that time, or even just remain steady. Remember that the homes are generally priced with 3 years of appreciation in mind.
Is rent-to-own the right move for you?
Homeownership is a massive moment in anyone’s professional or family life, and most relative financial commitments are upwards of 30 years in length. With a rent-to-own contract, that commitment is less binding and you have the chance to leave the agreement without too much of an investment going astray.
Rent-to-own situations have their cons, but if you’re in a position to get your proverbial feet wet with the thought of owning a home, this is a great option to ease into a life where you own a home!
What is the difference between rent-to-own and mortgage?
The major difference is the level of commitment. If you have the money for a mortgage, it benefits you to buy outright. If you’re still building your credit score or saving, a rent-to-own agreement allows you to start paying towards a home while having a fallback.
Can you buy a house and rent it out?
Yes, and many rent-to-own situations were just that before the rent-to-own agreement. Buying a house to rent it out is a great way to make some extra money.
Is renting a waste of money?
Renting helps you build credit, and allows you to have a lot more freedom to move. If you’re renting a house you want to live in for 30 years, it could be argued that renting is a waste of money. It all depends on the individual situation.