Rent to Own Homes: How They Work and Where to Find Them

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If you’re currently renting and aspire to purchase a home, a rent-to-own agreement can help you achieve your goal. Also known as a lease purchase, rent-to-own homes may be attractive to borrowers who have the income, but not the credit, to buy the home of their dreams. These hybrid lease/purchase agreements allow you to lock in the price of the property today while renting the home out on a "test-drive" basis. Rent-to-own agreements can offer a path to homeownership even if you have a low credit score or haven’t saved enough for a standard down payment.

What is a Rent-to-Own Home?

Rent-to-own or lease-to-own home purchases are contracts between homebuyers and sellers that allow for the sale of real estate over an extended period of time. They behave like hybrid lease agreements with an option to purchase the property at the expiration of the lease. There are two basic types of rent-to-own agreements: lease-option and lease-purchase. It’s important to understand the key differences between these two contracts before entering into any rent-to-own transaction.

Lease-Option Contracts afford you the opportunity to purchase the property at the expiration of the initial lease period—however you are not contractually obligated to buy it. These types of agreements are generally regarded as being more buyer-friendly. They are the best option if you’re uncertain about whether you want to purchase the property, as they give you the flexibility to change your mind once your lease is up.

Lease-Purchase Contracts require you to purchase the property at the end of the lease; this can be particularly difficult if you're unable to obtain financing when the lease ends, which can expose you to litigation. These types of agreement are more favorable to the seller, therefore you must be certain that you will be willing and able to purchase the home when the lease expires.

How Does Rent-to-Own Work?

Rent-to-own contracts typically last for a period of one to three years. They usually consist of three main components: the option fee, the purchase price and the rent premium.

Lease Option Fee: This is the upfront deposit that secures your ability to purchase the property in the future. The typical fee is between 2.0% to 7.5% of the home's agreed-upon purchase price, however it's usually negotiable. In a lease option contract, you will forfeit the fee if you decide not to purchase the property, however it can be applied to the down payment if you do decide to move forward with the purchase.

Purchase Price: The purchase price of the home needs to be agreed upon before entering into the contract. Determining the sales price upfront ensures that there is no back-and-forth between you and the seller when the time comes to complete the purchase. This will usually be set at, or slightly above the current market price of the property to compensate the owner for taking the home off the market.

Rent Premium: This is the portion of each monthly rent payment that is set aside for your down payment on the property. The seller holds these funds in an escrow account until you exercise your option and purchase the home. This also isn't refundable if you decide not to purchase the home, so it’s important to know exactly how much of your rent is going toward this premium. Note that your rental payments during the lease period will typically be above the market price due to the rent premium.

To illustrate the costs of a rent-to-own agreement, say you want to rent-to-own a home that costs $250,000. If the lease option is 2%, you’ll need to pay $5,000 upfront. You will then need to pay $1,700 each month in rent, with $200 of that going toward the rent premium. At the end of a five-year lease, you’ll have $17,000 set aside in escrow toward the purchase of the home—$5,000 from the initial option fee and $12,000 from five years' worth of monthly rent premiums. This can be contributed to the down payment on the home, or it will be forfeited if you decline to purchase the home (lease-option contracts only).

What Happens After the Lease Expires

In most cases, you’ll need to obtain a mortgage to complete your purchase of the property, unless you plan on walking away after the lease period expires. If you intend to purchase the home, it will make sense to apply for a mortgage at least a month or two before your lease period expires. Hopefully, you'll have built up your credit profile at this point to qualify for competitive financing.

If you're unable to obtain a bank loan, another option is seller carry financing, where the seller will "carry" the loan while you make principal and interest payments on the home. Essentially, this is similar to a regular home purchase, but the seller also takes on the role of lender. This may be agreed upon at initiation or put in place at the end of the lease period.

If the seller has an assumable mortgage on the property, it’s also possible for you to assume their loan—taking over their payments and being added to the title and deed. These types of transfers are rare, however, as the majority of mortgages are not assumable; those that are will require you to separately qualify for the assumed loan based on your ability to repay.

Most conventional mortgages are not assumable, however certain mortgages obtained through the FHA or VA may allow for loan assumption. The seller will need to inquire with their lender on whether this practice is allowed for their home loan. You'll also need to buy out any existing equity that the seller has in the property, which can amount to a sizable down payment.

Who Should Consider a Rent-to-Own Home?

Well-qualified borrowers who need to save money for a down payment but want to lock in their purchase price today can be good candidates for rent-to-own agreements. In high-cost and rapidly appreciating real estate markets, obtaining a nonconforming (or jumbo) mortgage can be difficult. Rent-to-own agreements can be a good way for prospective homebuyers to secure a purchase price while they build up their savings.

First-time homebuyers may also wish to consider a rent-to-own property. Strict underwriting guidelines can be a significant barrier to entry. Recent entrants to the job market may have trouble qualifying for a home loan, as most mortgage lenders require at least two years of verifiable income and tax filings, regardless of how high your income is. Rent-to-own agreements allow you to lock in your purchase price while allowing you more time to build your credit history.

Borrowers who qualify for a mortgage and have funds available for a down payment may prefer buying a property outright over the rent-to-own process. The purchase of the property can be handled in a single step without the extra cost and complexity of a rent-to-own or lease-to-own agreement. You can also avoid having to make high rent payments that could otherwise be entirely applied toward a mortgage.

Pros and Cons of Rent-to-Own Homes

Consider these pros and cons before entering into a rent-to-own contract:

Advantages of Rent-to-OwnDisadvantages of Rent-to-Own
  • You don’t have to wait until you’ve saved up for the down payment and qualified for a home loan to move in.
  • You secure the price of the home upfront, an advantage in appreciating real estate markets.
  • A portion of each rent payment is contributed toward your eventual down payment on the home, so you’re investing in equity.
  • You can change your mind about buying the property if it doesn’t meet your needs and expectations (assuming it's a lease-option agreement).
  • Your upfront fees and rent credits are nonrefundable if you don’t exercise your option to purchase the home.
  • You may be responsible for maintenance cost, HOA dues and even property taxes.
  • You may be contractually obligated to purchase the property at the end of the lease (assuming a lease-purchase agreement).
  • If you choose not to exercise your option, you end up paying above-market rents.

Important Considerations

Rent-to-own agreements lock you into a purchase price today in addition to a multi-year lease commitment; which essentially ties you down for the foreseeable future. This type of agreement does entail a significant amount of risk and should not be taken likely. It's therefore important to consider the following items before signing a rent-to-own contract.

Get Legal Help: Consult with a qualified real estate attorney to make sure you understand all of your rights and obligations under the contract. They can also assist with contract negotiations and confirm that the property is in good standing without title or tax issues looming.

Understand the Contract: Read every detail of the agreement and make sure you understand key details, such as due dates, your option fee, rental payments and credits, and how to exercise your purchase option when the time comes.

It’s important to pay attention to the responsibilities of each party, including who is responsible for maintenance and repairs during the lease period, as well as who is expected to pay HOA dues or property taxes.

Follow the Traditional Purchase Process: Obtain an independent appraisal, conduct a home inspection and complete a title search. Don't just assume the property is devoid of any issues just because you didn't encounter any during your lease term.

Conduct Due Diligence When it Comes to the Seller: Watch out for any red flags like collections, tax liens or judgments. If the property is at risk of foreclosure, or tied up in bankruptcy proceedings, you should steer clear.

Protect Your Investment: Note how much you’re paying upfront as well as the percentage of your rent payments being contributed to your rent credit (and eventual down payment). These funds should be held in a separate escrow account, not commingled with the seller’s other accounts. Avoid any penalties for late or missed payments, as these could jeopardize your ability to purchase the home later on.

How to Find Rent-to-Own Homes Near Me

Your best bet is to find a homeowner whose property has been on the market for while (typically over 3 months), and has decided to rent out the property instead. Most homeowners may be reluctant to entertain the idea of a rent-to-own agreement, but you may sway their opinion by offering to take over repair and tax costs as part of your agreement. Due to the uncommon nature of these agreements, much of the terms are up for negotiation.

Generally speaking, rent-to-own homes are more common in smaller cities and towns, where the real estate market isn't particularly active. While you're unlikely to find much in the way of specific rent-to-own listings, places like foreclosure.com may list a few options in your state. You may also be able to find dedicated rent-to-own sites that specialize in your locale, particularly if you live in larger cities.

A final option is to browse sites like Zillow and Trulia for properties that have been listed both for sale and for rent. With luck, you may be able to convince the seller to accept a rent-to-own agreement, particularly if the house has been on the market for a while. It's a good idea to consult your real estate broker before employing this strategy, as they may be better positioned to propose the idea to the seller's agent.

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