The firs time home buyer can be faced with numerous obstacles when trying to buy a home for the first time. The obstacles can be in the form of low credit score or no credit score, lack of funds for the down payment, inability to qualify for mortgage, etc. Additional reason to maintain a good credit score. As with everything else, there is also solution for this problem. Namely, you should get familiar with the rent to own home option.
What is rent to own home?
Rent to own home is a process in which the renter has the option to purchase the home at a previously determined price, before or at the expiration date. The process of rent to own can also be called an option to buy or a lease option. The interesting thing is that this option is not very popular among renters and home buyers. Even though it is primarily intended for buyers who can not otherwise afford a home.
In simple words, rent to own a home can be attractive option since you pay monthly rent as you would otherwise do with classic renting of a property. The difference being that you will pay higher monthly rent. Portion of the rent is accumulated in the form of rent credit. This rent credit, later on is used towards the purchase of the home. Depending on the rent to own lease agreement there might be some additional fee.
How rent to own works?
The property is rented in accordance to the basic home lease. If the tenant agrees to pay an extra money each month, then he/she will have the option to purchase the home. The purchase can take place at a later date (usually after three to five years) at a previously determined price.
For instance: current value of home is $220,000. Both landlord and tenant agree that the tenant will have the right to purchase the home in four years for $260,000. Noteworthy mentioning is that the tenant has the right but not the obligation to buy the home. Coming back to the example, the fee for the purchase option is around 2% of the purchase price. So 2% of $260,000 equals $5,200. Moreover, the tenant makes $150 extra payment each month. Thus, at the end of the four years term, the tenant has put up $12,400 towards the purchase price. The accumulated amount which goes towards the purchase price depends on the option fee as well as the amount of extra fee paid each month.
At the end of the agreed period, tenant decides whether or not the he/she will exercise the right to buy the home. The accumulated credit ($12,400 in the example above) can be used for a down payment.
There can be some differences regarding the process of rent to own from one agreement to another. But in general rent to own process is as follows:
- The renter is reach a decision and agrees to lease the property for predefined period. The predefined period is usually one to three years.
- The renter should pay an up-front fee, known as the option fee. Usually this fee can be up to 5% of the agreed purchase price for the home. Noteworthy mentioning is that this up-front fee in most cases is nonrefundable, though it portion or the entire amount can be considered as a down payment.
- There is also the possibility that the renter could pay a higher monthly rent. As with the fee, portion of the rent will be directed toward the down payment fund.
- Home’s purchasing price is fixed after the agreement is signed.
- The renter has the possibility to buy the home before or on the predefined expiration date of the lease agreement.
Advantages of rent to own home
Aside of the fact that it is not very popular option for renters, rent to own option has some advantages for potential home buyer.
Fixing the purchase price
With rent to own home you are basically fixing the purchase price at the current market value of the property. This value is appraised when you sign the lease agreement. Thus, this characteristic can also be considered to be both, advantage and disadvantage for buyers. It would be beneficial if you are leasing the property in times of depressed housing market (an example would be the time during the last financial crisis). Buy leasing a home at a depressed value, you stand to gain much more in the long run. Namely, you will lock in the price of your home, whereas in the future the value is expected to increase as the economy recovers.
The drawback though, is that you might find yourself signing a rent to own agreement in times when the home market is at maturity. This means that you will fix a price which can be higher than the expected value of the property.
A possibility to own a home
Rent to own agreement is offering more options for both sellers and buyers. Namely, people who can not afford to buy a home have the possibility to do so, through the lease agreement. On the other hand, homeowners can now sell their property even to buyers who can not afford the down payment.
You have an increased flexibility when buying your home. Namely, with the standard purchase of a home, you can not change your mind. If you do so, you have to find a buyer for your property. With rent to own agreement you are not obliged to buy the property. You should be aware that you will lose your rent credit.
Time to accumulate savings
Not being obliged to have a down payment on your property can have significant positive impact on your finances and/or savings. If you are not able to make the down payment then you will not be able to buy the property. But with rent to own agreement you do not need down payment, making it easier for you to buy a home. In addition, since you do not have a massive outflow of capital, you are able to save money in the long run.
Improve your credit score
In case you have low credit score, rent to own home option can help you. Namely, making on time payments for rent will increase your credit score.
Disadvantages of rent to own
Failure to understand and take into account the drawbacks of rent to own lease might have negative impact on your home buying plans in the future. For this reason, before making any decision, get acquainted with the problems with which could arise from rent to own agreement.
Costly form of home purchase
One of the disadvantages of rent to own form of agreement is the cost for its tenant’s i.e. potential home buyers. Namely, the cost for renting a place with a purchase option will have higher price. Landlords will charge you more for this form of lease. The charge can be in the form of additional charge added to your rent or you could pay a separate fee. In addition, it can also be embedded in a higher monthly rent. Keep in mind that part of the monthly rent goes to paying for the home. In case that the renter decides not to purchase the property, the landlord (owner) forfeits the additional charge.
Home ownership is not definite
One disadvantage of rent to own home agreement is that it doesn’t guarantee a home ownership at the end of the deal. This largely depends on the agreement terms. Thus, the renter should be careful when signing the document. Make sure that you have fully understood all terms.
No mortgage – no ownership
Most probably the renter would need to be approved for a mortgage in order to buy the property at the end of the agreement. But the thing is that you do not have a guarantee by the bank that you will be approved the mortgage. So if the renter is not able to obtain mortgage he/she will not be able to buy the home. Meaning that signing the rent to own home agreement is not a definite guarantee for a home ownership. In addition, if you do not qualify for a mortgage, the landlord will keep the tenant’s rent credit.
Losing the rent credit
When signing the rent to own agreement, tenant should pay extra amount to the landlords (rent plus the agreed monthly amount). Consequently, if you are not able to purchase the property for whatever reason, you stand to lose the rent credit you have paid. So instead of renting smaller home a saving money, the renter could end up paying higher rent without owning a home at the end.
Decrease in property value
Because the purchase price is predetermined and fixed with the rent to own contract, you can end up buying a more expensive home, compared to the current market value. Namely, the value of home can change during the agreement period. Thus, the value of the home can decrease and it will be actually cheaper to buy the home at the market value, and not at the agreement price. For instance, according to the agreement you can purchase the home for $180,000 after five years. But the market value of the home after five years has decreased down to $145,000. In case you decide not to execute the contract term you will lose the accumulated rent credit. Keep in mind though, that the market value of the home can also increase for instance up to $200,000. So you also can gain higher value for lower price.
Cancellation of agreement terms
Major disadvantage of rent to own a home is the contract terms. Namely, one late payment can result in cancellation of the entire agreement. In addition, if the home repairs obligation is not clearly defined, the tenant can lose the contract if some repairs are not finished. So tenant should be careful about the terms with which the landlord can void the contract.
Issues to consider before rent to buy agreement is signed
Above all, it is wise step to ask for a legal advice regarding the rent to own home lease agreement. Don’t sign any agreement until you have understood the terms (especially the details) of the agreement. If you don’t feel comfortable with some of the terms you either ask for those terms to be changed or look for new property. That being said, there are couple of issues you should consider before signing a rent to own agreement. Of course the issues should be considered from buyers and sellers point of view.
Issues to be considered as a buyer of a rent to own home option:
- Under which circumstances the tenant is losing the right to purchase the property. When the agreement is canceled. According to some agreements, being late on rent once could mean cancellation of agreement. In this case when the contract is no longer valid, the landlord can forfeit the extra charge.
- The consequences in case of a late rent. Make sure that you have taken into consideration the possibility of a short term problems with finances.
- The landlord might perform a credit and background check. The purpose is to see whether the tenant will be able to purchase in the property.
- Make sure that you can qualify for a mortgage.
- The property might be subject to foreclosure, since you do not own it yet, the landlord might lose the property. Make sure that the property is not going to be subject to foreclosure.
- This is a bit tricky, but try to find out the expectations about the future home prices. This will help to decide whether or not you will gain or lose on the value of the property when you buy it. Don’t forget that the purchase price is locked with the rent to own agreement.
- Are there any title problems associated with the property you want to buy?
- Always be aware about rent to own scams. Do not rush into things, make sure that you are communicating with a reputable person or agent or adviser.
- The agreement should clearly state about the responsibilities associated with the home. Make sure that the lease option is states who is responsible for the repairs and maintenance associated with the home. In addition, the types of modification the tenant is allowed to make should also be stated.
Issues to be considered as a seller of a rent to own home option:
- There is always the possibility that your renter will not buy the property. Meaning that the process for selling your home will start all over again. The good thing though is that you get to keep the extra money.
- You get the money in installments instead of a lump sum. Thus, you may not be able to buy another property immediately.
- Since you lock in the price, you risk to lose money if the home prices increase.
- On the other hand, if home prices decrease then the renter might decide not to buy the home from you. So now you need to sell your home at lower prices.
- The agreement should define the responsibilitie regarding the repairs and maintenance of the home.
Before signing any rent to own agreement, both, landlords and tenants (seller and buyer) should ensure that they have fully understand the conditions under which the transaction will take place. In addition, you should be acquainted with the benefits and pitfalls of rent to own home. Keep in mind that this form of agreement can be subject to different problems, since it doesn’t have any standardized agreement.