If you're in the market for a new property, chances are you'll need to qualify for a mortgage. That can be far trickier than finding a home that you like – especially if you need to build or repair your credit. For this reason, you may be interested in a rent-to-own property.
With a rent-to-own contract, there is a two-step process: First, you'll rent a house with a standard lease agreement for a period of time, with some of your monthly payment going toward an eventual down payment. Then, once the lease expires, you'll have the option to purchase the property.
If you're contemplating going through the rent-to-own process, you'll need to tread carefully. There are a variety of pitfalls associated with rent-to-own agreements, including the risk of losing your down payment money if you aren't prepared to finance the rest of the property once the lease ends. You also want to make sure you're doing business with a reputable company or homeowner, rather than an unscrupulous seller.
Here's a primer on how rent-to-own deals work and potential risks to be wary of before you commit.
How Does a Rent-to-Own Arrangement Work?
In a rent-to-own contract, typically individual homeowners enter an agreement with a real estate company for three years, with the option to extend a lease contract for four additional years.
"A rent-to-own contract will detail several things: your rent payment, (the) length of your lease, what you need to do to buy the home, the time you have to buy the home, how much you will pay for the home, potential rent credits and an option fee, which may be named something else," says Misty Weaver, a realtor in Chantilly, Virginia.
Buying a home may not be wise if your life is in flux or dealing with repairs frightens you.
The option fee, which is often between 2.5 percent and 7 percent of the purchase price of the home and is required before you move in, may be referred to as option money or option consideration. "An option fee is usually negotiated in order to show that you are serious about buying the home with a traditional loan within a certain number of years," Weaver says.
Regardless of the number of years you're planning to rent, part of your monthly payment (say, 20 percent) will go toward your down payment. And keep in mind, the rest of your monthly payment will likely be above the average rent in your market. After two or more years, you'll have accrued the amount you'll need for a down payment – or part of the necessary amount.
The principle with rent-to-own agreements is having at least some money put toward a down payment when the lease ends, with the goal of either paying the rest when the contract expires or extending the contract.
The Benefits of a Lease Option vs. Lease Purchase
You'll want to be careful before signing a rent-to-own contract, and ideally have a real estate attorney involved and discuss any of the fine print. In fact, you should involve two lawyers, says Brenda Di Bari, a commercial broker with Halstead Real Estate in New York City. "It is crucial that an attorney prepare the contract and that the buyer have that contract reviewed by an independent attorney to be certain their interests are protected," Di Bari says.
For instance, some of the things a contract should address is whether a renter is entering a lease-option or a lease-purchase agreement. With a lease-option contract, you don't have to buy the house when the lease is up and you can walk away after the lease ends. But there is a snag: With a lease-option arrangement, you typically won't get the money put toward a down payment back. Conversely, with a lease-purchase contract, at the end of the lease, you are legally obligated to buy the house.
Another thing to look for in the contract: if the option fee is included as part of the down payment. According to Weaver, many times the fee is not included.
Where to Find a Rent-to-Own Company
There are a number of rent-to-own companies that specialize in rent-to-own arrangements, including Home Partners of America, which has rent-to-own homes in 20 states, and Verbhouse, which covers homes in San Francisco. If you're interested in purchasing a home with a rent-to-own contract, perhaps because you don't have much money for a down payment or have shaky credit and want a few years to boost your finances, you should alert your real estate agent. It's a common agreement for prospective homebuyers, and your agent may be able to find home sellers who are interested in doing a rent-to-own sale.
Do Your Research
Remember, the rent-to-own process can be fraught with peril. Di Bari points out that if you lose your job while renting your home and you can't make a monthly payment, you could – if the contract is worded in the seller's favor – lose the down payment money you've provided. You could even be evicted.
Think of it this way: If you have a good, well-paying job, but you haven't raised the money for a down payment or you could use a few more years to build your credit, you may be an ideal candidate for a rent-to-own home agreement. And if you're a prospective buyer looking to get approved for a mortgage in an expensive area and you want to bolster your credit by building equity, a rent-to-own agreement could be an ideal choice. But if you have poor credit and live paycheck to paycheck, a rent-to-own contract can be a risky proposition.
Other questions Di Bari suggests prospective homebuyers ask include: "What if the market dips and you're locked into a purchase price that is no longer advantageous? Or (what if) the home will no longer appraise for a high enough amount to get your mortgage?"
Before you sign a rent-to-own contract, consider getting a home inspection and getting the house appraised. You should also make it clear in the contract that any property taxes due on the home while you're renting are the responsibility of the owner.
Also keep in mind that the contract will need to indicate who is responsible for maintenance and repairs, Di Bari adds. That last point is important. After all, if you fix the plumbing and patch a hole in your roof while renting the property and things don't go the way you plan, you may inadvertently be making your home nicer – for the next tenant.
Are these must-haves on your list?
One of the first steps you take when deciding you want a new home is determining what you need in order to be happy there. The list of your must-haves can get long, and you reasonably can’t expect to find a house that perfectly matches all your criteria. “Someone has a list of 10 things – if they can find a house that has seven or eight of those, they’re doing pretty good,” says Jeff Plotkin, a Texas-licensed Realtor, attorney, certified public accountant and vice president of Habitat Hunters Inc. in Austin, Texas. Deciding what needs win out in your next home search can be tough, but there are a few key features and amenities many buyers seem unwilling to live without.Right in your price range
Right in your price range
Being able to afford your new home is a given, but buyers are often faced with having to choose between stretching their budget to have the master suite they want or having more reasonable monthly mortgage payments. Price often wins out in the end – you’re less likely to enjoy that master suite if you’re eating soup and foregoing vacations for the next five to 10 years to pay it off. In the 2018 National Association of Realtors Home Buyer and Seller Generational Trends report, home affordability was one of the three most important factors for respondents who recently purchased a home – behind only quality of the neighborhood and a location's convenience to work.In your preferred location
In your preferred location
Homebuyers care a lot about being able to get from point A to point B – as well as points C, D and E. Your future neighborhood can dictate what school your kids go to, how long it takes to get to work and how easy it is to stop at the grocery store when you forgot an ingredient for dinner. Plotkin says buyers put a lot of stress on where the house is, rather than what’s in the house itself. They’re looking for “proximity to schools, shopping, entertainment, public transportation,” he says.Interior over curb appeal
Interior over curb appeal
A handsome exterior keeps potential buyers from quickly driving away, but insight from new construction marketing site HomLuv.com reveals that it’s the interior that most often serves as the deal-maker. HomLuv’s website allows homebuyers to begin their search for a new home from the room they care about most, whether that’s the kitchen, living room or master bathroom. The one part of the house people don’t seem too worried about? Outside. In the roughly two months since HomLuv launched, “no one has chosen to look at exteriors first,” says Mark Law, vice president of product management for BDX, a home builder marketing company and parent company of HomLuv.The right number of bedrooms
The right number of bedrooms
While the interior of the home allows more wiggle room to compromise on your needs, there are some details that buyers must have. The right number of bedrooms would be the big one. Family expansion is often a primary reason homeowners start looking for a new house, so leaving out that extra room would defeat the entire purpose of the sale. According to the NAR report, 85 percent of homes purchased by respondents in 2017 had three bedrooms or more.Window treatments for reference
Window treatments for reference
Staging matters in a home. As much as we think we can picture how a vacant house will look with our own furnishings and decor, at the end of the day we need some suggestions. Law says builders will include big picture windows in bedrooms or over the tub in a master bathroom to let in natural light, but if the photos show the space without curtains or blinds, house hunters will inevitably see a design flaw. “They’ll say, ‘I’m not an exhibitionist,’” he explains. To avoid turning homebuyers off, window treatments should be included in listing photos and for home tours.Move-in ready
The condition of the home you shop for often goes hand in hand with your budget and the neighborhood you hope to live in. If your budget is at the lower end of the price range in the hottest community in town, you’ll likely find yourself buying a house that needs a little love. If your budget doesn’t restrict it, chances are you’ll have your pick of properties that have been turned by real estate investors. “The [buyer] demand is for 100 percent move-in ready condition,” says Bobby Montagne, CEO of Walnut Street Finance, a private money lender focused on home flipping in markets in Virginia, North Carolina and the District of Columbia metro area.Possible to picture your vision
Possible to picture your vision
Even if you’re one of the detractors who prefers a fixer-upper, it’s still necessary to be able to envision how the space will look once you’ve added your personal touches. Based on reactions from HomLuv users, details as small as the cabinet color in a photo can change the way a person thinks about a house. Law says he’s found preferences differ from region to region – darker cabinets may see more love in the South, while in California the preference is for white kitchen cabinets. “You could offer a free puppy and free pots and pans with the house, but if the cabinets are dark they still don’t want it,” he says.Warranty available
For newly built homes and those that have been recently flipped with significant work, you want to know that the professionals involved stand by their work. New construction homes often come with a warranty from the builder or the option to get a third-party warranty, and you should ask the investors involved with a flip for the same level of protection. “A good builder [or] a good flipper does not have a problem with that,” Montagne says. If an issue arises within the life of the warranty related to the workmanship, you can rest easy knowing you’re covered financially for the repairs.Potential for value growth
Potential for value growth
Your home isn’t just where you’ll live – it’s also an investment. There are a few easy decisions you can make that reduce the chances of losing out on potential growth in value over time, whether that means buying in a neighborhood where home values are steadily growing, finding a home in a desirable school district or avoiding living next to a strip mall. “When you’re buying a house, you’re not only buying it for yourself, you’re buying it for resale,” Plotkin says. “So most people are not going to want to back up to commercial [property] or a busy road.”Read More
Williams got his start working in entertainment reporting in 1993, as an associate editor at "BOP," a teen entertainment magazine, and freelancing for publications, including Entertainment Weekly. He later moved to Ohio and worked for several years as a part-time features reporter at The Cincinnati Post and continued freelancing. His articles have been featured in outlets such as Life magazine, Ladies’ Home Journal, Cincinnati Magazine and Ohio Magazine.
For the past 15 years, Williams has specialized in personal finance and small business issues. His articles on personal finance and business have appeared in CNNMoney.com, The Washington Post, Entrepreneur Magazine, Forbes.com and American Express OPEN Forum. Williams is also the author of several books, including "Washed Away: How the Great Flood of 1913, America's Most Widespread Natural Disaster, Terrorized a Nation and Changed It Forever" and "C.C. Pyle's Amazing Foot Race: The True Story of the 1928 Coast-to-Coast Run Across America"
Born in Columbus, Ohio, Williams lives in Loveland, Ohio, with his two teenage daughters and is a graduate of Indiana University. To learn more about Geoff Williams, you can connect with him on LinkedIn or follow his Twitter page.