Rent-to-Own Homes: How the Process Works

A mortgage will be required if you are like the majority of homebuyers in order to finance the purchase of a new home. To be eligible, you must have a good credit score as well as the funds to put down as a down payment. In the absence of these, the traditional route to homeownership may be out of the question.

The option of a rent-to-own agreement, in which you rent a home for an agreed-upon period of time with the option to purchase it before the lease expires, is also available. Typically, a rent-to-own agreement is composed of two parts: a standard lease agreement and an option to purchase the property.

Here’s a quick rundown of what to look out for and how the rent-to-own process works in general. Renting a home is more complicated, and you’ll need to take extra precautions to ensure that your interests are protected. If you’re looking to buy a house, this will assist you in determining whether or not the deal is a good choice for you.

The Most Important Takeaways

It is possible to purchase a property through a rent-to-own agreement, which is a contract in which you agree to rent a property for a specified period of time with the option to purchase it before the lease expires.
Rent-to-own agreements consist of a standard lease agreement as well as an option to purchase the property at a later date, as opposed to traditional lease agreements.
Lease-option contracts give you the option to purchase the home at the end of the lease term, whereas lease-purchase contracts obligate you to purchase the home at the end of the lease term.
Throughout the lease, you will be required to pay rent, and in some cases, a portion of the rent will be applied toward the purchase price.
Some rent-to-own contracts may require you to maintain the property and pay for repairs, which you may not be able to avoid.

Nonrefundable Fees Paid Up Front

In a rent-to-own agreement, you (as the buyer) pay the seller a one-time, usually nonrefundable, upfront fee known as the option fee, option money, or option consideration, which is applied to the purchase price of the property. This fee is what gives you the option to purchase the house at a later date if you wish to do so. Because there is no standard rate for option fees, they are frequently negotiable. Despite this, the fee is typically between 1 percent and 5 percent of the purchase price in most cases.

Comparison of Lease-Option vs. Lease-Purchase

The fact that there are various types of rent-to-own contracts, some of which are more consumer-friendly and flexible than others, should be taken into consideration. Lease-option contracts grant you the right, but not the obligation, to purchase the property at the end of the lease term, if you so choose. The option to purchase the property simply expires at the end of the lease term, and you are free to walk away from the property with no obligation to continue paying rent or to purchase the property. When it comes to lease-purchase agreements, this is not always true.

It must be a lease-option contract in order to have the option to purchase without being obligated to purchase. Because legalese can be difficult to decipher, it’s always a good idea to have your contract reviewed by a qualified real estate attorney before signing anything. This will ensure that you understand your rights and exactly what you’re getting yourself into before signing anything.

Keep an eye out for lease-purchase agreements, as you may be legally obligated to purchase the home at the end of the lease, regardless of whether you can afford to do so.

Having reached an agreement on the purchase price

Rent-to-own agreements should spell out when and how the purchase price of the home will be determined, among other things. You and the seller may come to an agreement on a purchase price when the contract is signed, which is frequently a higher amount than the current market value of the property in question. The price is determined when the lease expires in other cases, based on the property’s current market value at the time of the lease expiration. The ability to “lock in” the purchase price is appealing to many buyers, particularly in markets where home prices are on the rise.

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Rent is being applied to the principal.

Throughout the duration of the lease, you will be required to pay rent. Whether a portion of each payment is applied toward the final purchase price is the subject of discussion. Rent credits can amount to $10,800 if you pay $1,200 in rent each month for three years and 25 percent of that is credited toward the purchase price ($1,200 x 0.25 = $300; $300 multiplied by 36 months = $10,800). A typical rent is slightly higher than the going rate for the area in order to compensate for any rent credit you may be entitled to. However, make certain that you understand what you’re getting in exchange for your premium.

In some contracts, you may be able to apply all or a portion of the option money you must pay toward the eventual purchase price at closing.

Home Maintenance for Rent-to-Own Properties

Depending on the terms of the contract, you may be liable for the upkeep and repair of the property as well as the payment of any repairs. Typically, this is the responsibility of the landlord, so be sure to carefully read the fine print of your lease agreement. In most cases, sellers choose to cover these costs because they are ultimately responsible for any homeowner association fees, taxes, and insurance (after all, it is still their home). A renter’s insurance policy is required in either case to protect your personal property and to provide liability coverage in the event that someone is injured while visiting your home or if you accidentally injure someone while at work.

Make certain that the contract clearly specifies the requirements for maintenance and repair work (ask your attorney to explain your responsibilities). Maintaining a property, such as mowing the lawn, raking the leaves, and cleaning out the gutters, among other things, is very different from replacing a damaged roof or bringing the electrical system up to current standards. Before signing anything, whether you’ll be responsible for everything or just for mowing the lawn, have the house inspected, order an appraisal, and verify that the property taxes are current.

Purchasing the Real Estate

What happens when a contract comes to an end is determined in part by the type of agreement you signed. Unless you have a lease-option contract and intend to purchase the property outright, you will almost certainly need to obtain a mortgage (or other financing) in order to make the final payment to the seller.

In the event that you decide not to purchase the home—or that you are unable to secure financing by the end of the lease term—the option expires and you are required to vacate the premises, just as if you were renting any other type of property. Any money paid up to that point, including the option money and any rent credit earned, will almost certainly be forfeited, but there will be no obligation on your part to continue renting or to purchase the property.

It is possible that you will be legally obligated to purchase the property when your lease expires if you have a lease-purchase contract. A number of factors can make this difficult, particularly if you are not able to obtain a mortgage. In almost all cases, lease-option contracts are preferable to lease-purchase contracts because they provide greater flexibility and because you do not run the risk of being sued if you are unwilling or unable to purchase your home when your lease expires.

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Prepare for the process in the same way you would if you were purchasing a home outright: conduct due diligence, research the neighborhood, compare prices with other nearby homes, research the contract, and research the seller’s background information.

If you are experiencing financial difficulties as a result of COVID-19, programs for renters and homeowners that prevent foreclosure and eviction, as well as programs that provide mortgage payment relief, are available from the federal government, states, municipalities, and private lenders as part of the coronavirus emergency stimulus package.

Identifying the Ideal Rent-to-Own Prospect

A rent-to-own agreement can be an excellent option if you’re interested in becoming a homeowner but aren’t quite ready to make the financial commitment just yet. These agreements provide you with the opportunity to get your finances in order, improve your credit score, and save money for a down payment all while “locking in” the house you want to buy down the road. If the option money and/or a percentage of the rent are applied toward the purchase price, as is frequently the case, you will also be able to accumulate some equity.

While rent-to-own agreements have traditionally been geared toward people who are unable to qualify for conforming loans, there is a second group of candidates who have been largely overlooked by the rent-to-own industry: people who are unable to obtain mortgages in expensive, non-conforming loan markets, such as those in California and New York. As Marjorie Scholtz, founder and CEO of San Francisco–based start up Verbhouse, explains: “In high-cost urban real estate markets, where jumbo (nonconforming) loans are the norm, there is a significant demand for a better solution for financially viable, creditworthy people who can’t get or don’t want to get a mortgage yet.”

Scholtz explains that as home prices rise and more and more cities are priced out of conforming loan limits and forced into jumbo loans, the burden of responsibility shifts from consumers to the mortgage industry. Even financially capable people may have difficulty obtaining financing in these markets because of strict automatic underwriting guidelines and down-payment requirements ranging from 20 percent to 40 percent of the loan amount.

In Scholtz’s opinion, “anything unusual” (such as a significant increase in income) “tosses good income earners into a ‘outlier’ status because underwriters are unable to fit them neatly into a box.” Those with nontraditional incomes, such as those who are self-employed or contract workers, or who do not have a credit history in the United States (foreign nationals, for example)—as well as those who simply do not have the large 20 percent to 40 percent down payment that banks require for nonconforming loans—fall into this category.

Verbhouse is unique in that it offers rent-to-own properties in high-cost markets, which makes it stand out among other rental properties. However, all prospective rent-to-own home buyers would benefit from attempting to incorporate the following consumer-centric provisions into their lease agreements: The option fee and a portion of each rent payment are used to reduce the purchase price dollar-for-dollar. The rent and purchase price are both locked in for up to five years, and participants can accumulate equity and benefit from market appreciation even if they decide not to purchase at the end of the term. As explained by Scholtz, participants have the option to “cash out” at the fair market value, in which case Verbhouse sells their home and they keep the market appreciation, as well as any equity they’ve built up through rent “buy-down” payments.

Be Sure to Read the Contract Before You Sign It

The following steps should be followed if you are considering buying a lease-option property. Make certain to:

Select the Appropriate Phrases

Instead of a lease-purchase agreement, you should enter into a lease-option agreement.

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Help Is Available

Engage the services of a qualified real estate attorney to assist you in understanding the contract and your rights and obligations. You may want to negotiate some points before signing the contract, or you may want to walk away from the deal if it is not favorable to you.

Investigate the Terms of the Agreement

Make certain that you understand:

  • The deadlines must be met (what is due when)
  • The option fee and rent payments–as well as how much of each is applied toward the purchase price–are discussed in detail.
  • The method by which the purchase price is determined
  • How to exercise your right to purchase a home (for example, the seller may require you to provide advance notice in writing of your intent to buy)
    Whether or not pets are permitted
  • Who is responsible for upkeep, homeowner association dues, property taxes, and other costs associated with a home?
  • What is meant by “maintenance” is as follows: Whether it’s simple chores like mowing the lawn and raking leaves, or more serious repairs like repairing a roof,
    Investigate the Residence

Order an independent appraisal, have the property inspected, check to see that the property taxes are current, and check to see that there are no liens against the property, among other things.

Look into the Seller’s background.

Check the seller’s credit report for signs of financial difficulty, and obtain a title report to determine how long the seller has owned the property—the longer the seller has owned the property and the more equity they have, the better the deal is likely to be.

Double-check the fine print before you sign anything.

What are the conditions under which you would be unable to exercise your option to purchase the property? You may lose this right if you are late on just one rent payment or if you fail to notify the seller in writing of your intent to purchase under the terms of some lease agreements.

What’s the bottom line?

Potential home buyers can move into a home immediately after signing a rent-to-own agreement, giving them several years to work on improving their credit scores and/or saving for a down payment before attempting to obtain a mortgage. Of course, certain terms and conditions must be met in order to complete the rent-to-own transaction in accordance with the agreement. If you’re buying or selling a home, even if a real estate agent is assisting you, it’s critical that you consult with a qualified real estate attorney who can explain the contract and your rights before signing anything.

What is the difference between renting to own and purchasing a home?

Renting to own is essentially a hybrid approach to home ownership in which all or a portion of a lease payment is used to accumulate equity in a home over a period of time. It is typically defined as a process by which the owner of a home allows a renter to accumulate equity without having to make a down payment or obtain a loan.

What are the benefits of a rent-to-own arrangement?

In some cases, renting to own may be an excellent option for people who want to begin building equity in a home without taking out a mortgage or making a significant down payment. If you don’t have the financial means to make a down payment because you don’t have enough savings or if your credit score is too low to qualify for a mortgage, this can be especially beneficial for you.

What factors should be taken into consideration when renting to own?

Rent-to-own agreements can be extremely variable, necessitating the renter’s exercise of caution and due diligence. It’s critical to thoroughly research the contract (possibly with the assistance of a real estate attorney), thoroughly research the home (with an appraisal and inspection), and thoroughly research the seller before making a decision.

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