In theory, the idea behind a rent-to-buy arrangement is a good one for those who want to purchase a home but aren’t quite ready yet. More than anything, it gives buyers hope, and often a solution to their credit woes, while locking in a home that will, presumably, belong to them one day.
“One of the main reasons why rent-to-own agreements are attractive to renters is because they can engage to a contract even though they have a bad credit status,” said Passive Real Estate Investing. “He or she can improve their credit rating by renting the property and later on, they may be able to get a loan to purchase the property.”
Another benefit of renting to own is that it “allows buyers to lock in a purchase price, which can be especially beneficial in a time when home prices are on the rise,” said Quicken Loans. “If the option money or a percentage of the rent is applied to the home’s purchase price, you can also begin to build equity in the home before you even purchase it.”
Prospective buyers also get a test run of sorts to figure out if it’s the right house and the right area, or if they need to start their search over. “If that’s the case, they can walk away,” said Passive Real Estate Investing. “Of course, they lose whatever premium they’ve been paying above and beyond what the regular rent one of been.”
That premium is perhaps the biggest negative of entering into a rent-to-own arrangement. First, there’s the upfront money. “In a rent-to-own agreement, you (as the buyer) pay the seller a one-time, usually nonrefundable, upfront fee called the option fee, option money, or option consideration,” said Investopedia. “This fee is what gives you the option to buy the house by some date in the future. The option fee is often negotiable, as there’s no standard rate. Still, the fee typically ranges between 2.5% and 7% of the purchase price.”
You can expect to pay more per month, too. “Typically, the rent is slightly higher than the going rate for the area to make up for the rent credit you receive,” said Quicken Loans. “But be sure you know what you're getting for paying that premium.”
And that’s not the only downside. “In the end, when you decide not to buy the property, you will lose all the money you paid including the initial premium payment,” said Passive Real Estate Investing. “Also, in cases of missed or late payments, you may lose the option to buy the property.”
You’ll also want to make sure you read the contract carefully so you know the terms. “Some landlords include a lease-purchase in their rent-to-own agreement, which legally obligates the renter to purchase the home at the end of the lease,” said Quicken Loans.
A new way to rent-to-own
Divvy Homes is a new player on the rent-to-own scene that may be the answer for buyers looking to get into a home while mitigating some of the potential drawbacks to a more typical arrangement. Divvy works with buyers to figure out the budget that is comfortable for them and requires just 2% down while covering “all fees, closing costs, taxes and insurance.”
“You pick the house you want to buy—not just any house,” said Marketplace. “Around 20 percent of your monthly rent goes toward what Divvy calls ‘equity credits.’ “After three years, renters own 10 percent, typically enough to qualify for a mortgage and buy Divvy out.”
Divvy also refunds some of the money for those who opt not to purchase the home. “If they leave or default before three years, they’ll get back half of the equity they’ve built.”