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Do you feel emotionally ready to buy a home, but your lack of capital or credit score has resigned you to renting? There is a middle ground: a rent-to-own home. This arrangement is a godsend to renters who want to build equity in a home without surmounting the hurdles that come with an outright home purchase, which involves saving for a down payment and taking on a mortgage.
So how do you find such a dreamy scenario to go from renting to becoming a homeowner? Read on for the steps to take and pitfalls to avoid when looking for a rent-to-own home.
Pick a place that’s ripe for a rent-to-own arrangement
Finding a property owner agreeable to a rent-to-own scenario might not be easy.
“Probably about 5% of the market is transactions such as this,” says real estate agent RJ Avery of Richardson, TX. And they tend to be in smaller cities or towns—transitional areas, where the real estate market isn’t very desirable or competitive.
In short: You might have to find real estate to rent, and then purchase, in areas that might not have everything you’d like, such as a good school district or great restaurants down the block. But these areas likely offer the best rent-to-own real estate finds. In those areas, a property owner might be eager to just go ahead and lock in a decent purchase price, rather than offer a lease option and work with renters.
Locate a reluctant landlord
Your best bet are property owners who reluctantly backed into becoming landlords—in other words, they tried to sell the home, were unsuccessful, and then began renting it out to tenants instead.
Unlike landlords who own many properties and are committed to raking in rent dollars, these landlords by default often own just one property, and might be eager to get the property off their hands through a rent-to-own agreement. They may also be willing to work with you to come up with a purchase price that works for you in the rent-to-own agreement, which could help you obtain an affordable mortgage.
Additionally, typical rent-to-own agreements specify that repairs and upgrades be made by the tenant (like most terms, of course, this is negotiable), an item that could also sway wavering sellers looking to minimize their obligations as landlords and go with a lease option or rent-to-own agreement.
Know your options
There are numerous elements and potential details in a rent-to-own arrangement, but most of these agreements follow the same basic principles—the potential buyers and sellers agree on the following before signing a lease or entering into a rent-to-own agreement:
- A time frame to transition from rent to own (anywhere from a few months up to five years) that works for both landlord and buyer
- The home’s purchase price (either locked in or to be determined by the end of the lease)
- An option fee—a nonrefundable deposit, paid in addition to rent, but typically credited upon sale to the buyer—to secure the right to purchase the property (Similar to a down payment on a mortgage, this is typically anywhere from 2.5% to 7% of the home’s price.)
- The home’s rent (Landlords will typically set rent slightly above market; that way, a portion of rent will include equity in the purchase property, typically between 25% to 50% of the total rent.)
Are you ready for a mortgage? Homeownership is a rewarding experience and smart financial move, but home buying is an extensive process and taking on a mortgage brings much more responsibility than renting real estate.
To purchase the home outright, the renter, or buyer, must be approved for a mortgage, which involves a credit score check. The buyer will then be responsible for paying the mortgage each month, just like paying rent, but each mortgage payment takes them one step closer to being a homeowner. Not doing so could harm your credit score and lead to a potential foreclosure.
Assess the risks
There are actually two types of lease options: a lease-purchase and a lease-option.
With a lease-purchase contract, buyers are locked into the purchase by the conclusion of the lease. If you don’t abide by this lease contract, you will forfeit all of the rent you’ve supplied to the landlord over those years, which is essentially your down payment, and could also face legal action over the lease.
Buyers who choose this purchase route should be absolutely clear on their long-term plans and financial outlook. Plenty can happen in a buyer’s life and livelihood that could affect whether he can (and wants to) purchase this house, sign the lease, and handle the mortgage payment.
A lease-option contract is less rigid. In this lease arrangement, buyers can choose whether or not to purchase the home by the end of the lease, and the landlord must honor it. This lease agreement gives you a choice to opt out of the purchase within the agreed-upon time frame, offering a bit more wiggle room if you’re uncertain about the purchase price or whether you want to rent to own the place. But even in this case, you might forfeit your deposit, or down payment, and equity. So before you rent, it’s important to be sure that rent to own is the direction you really want to take to buy the home and that the purchase price is right for you.
Is rent to own right for you? Only you and your landlord can determine that for sure and which lease option will work best for your situation. If you are renting a property you love, need the time to improve your credit score and/or save up the down payment, and have an amenable seller, it might be the right choice.
Still, in most typical rent-to-own cases, “it’s usually better to buy outright—but it is case by case,” says Avery. “Whatever you decide, it’s always best to consult an attorney or licensed real estate broker to be sure you have all the facts.”