How Does Rent-to-Own Work?

Written by Ashley Sutphin Posted On Wednesday, 07 April 2021 00:00

If you want to buy a home, one agreement option available is rent-to-own. Of course, not every homeowner is going to agree to it, and it comes with a set of pros and cons.

The following is a breakdown of everything you should know about rent-to-own when it comes to buying a house.

The Basics

A rent-to-own purchase has appealing elements, but there are risks.

Basically, when you enter into this type of contract, you agree that you’ll rent a property for a set period of time before you then gain ownership. The time you rent can be a few months to several years, dependent upon your contract.

An individual can own the property, or a company might.

The contract dictates that the seller will keep a certain amount of money from each rent payment. That goes toward the equity when the buyer purchases the property.

There are two specific types of agreements that are categorized as rent-to-own. There’s a lease option agreement and a lease-purchase agreement. When you follow the lease option agreement, you have the option to buy the home after the time you agree on. On the other hand, with a lease-purchase agreement, you have a legal obligation to buy the house.

The Process

While every process might have its own unique elements, some of the things to anticipate in a rent-to-own transaction include:

• First, the agreement will specify a purchase price. The price could be based on the current value of the home or perhaps the estimated future value. It could be that there’s an official price when a buyer and seller agree to a contract and sign it, but other times, the purchase price is decided when a lease expires.
• Then, as part of your contract, you pay a set amount of rent each month. You can expect that the rent payment is going to be more than comparable rent prices in the neighborhood because a portion is being set aside toward your future purchase.
• The seller may ask you to cover all maintenance expenses, so when you enter into one of these agreements, it’s important to know exactly what you agree to.
• You pay the seller a one-time fee which isn’t refundable, and then some sellers will put that toward your equity in the home. It’s usually calculated as a percentage of the purchase price of the home.
• Your contract will dictate a specific lease term.
• If you are going to buy a house at the end of the lease term, you’ll need to get financing, so there will be a closing date set.

The Pros of Rent-to-Own

For buyers, the upsides of rent-to-own agreements include:

• You’re gradually building your down payment rather than having to come up with a large sum upfront and all at once.
• You don’t have to worry about competition from other buyers when you’re ready to purchase.
• You don’t have to qualify for a mortgage right away, so you can work on building your credit score.

The Cons of Rent-to-Own

While it might initially sound great, there are quite a few downsides to a rent-to-own agreement.

• You’re going to pay more in rent than you would for a comparable home because you are essentially being forced to set aside a down payment. At the same time, you could also rent a home that’s less expensive and then put your own money aside in an interest-earning bank account to work toward your down payment.
• You do still have to pay the option money that isn’t refundable, including if your deal ends up not working out.
• You are likely going to have to pay for all the maintenance and repairs on a home that you don’t yet own.
• If the value of the home goes down, you might be stuck with a purchase price in your agreement that’s much too high.
• There are situations out of your control that could cause you to lose the equity you put in the home. For example, if the home were to go into foreclosure, it goes to the bank.

You have to weigh the pros and cons of your personal financial situation and decide what works for you.

It’s often more advantageous as a buyer to get your finances in order and go the traditional route, as opposed to rent-to-own.

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