Eventually everyone trips across the term "rent to own" in their home search journey. If you've ever asked yourself "what is a rent to own home?" and wondered whether it's a good idea, you are on the right page.
If you've leased a car, then you already know the basic principles of a rent to own agreement: the seller remains the official owner of the asset, while the buyer makes non-negotiable monthly payments for a predetermined period of time. At the end of that period, the buyer can decide to purchase the asset or walk away.
Rent to own follows the same concept, with the buyers paying a higher rent price to make contributions towards a down payment. Let's say the rent on a home is usually $1000. In a rent to own option, the buyer may agree to make monthly payments of $1200 instead. The first $1000 still goes towards the regular rent, while the extra $200 is a rent credit.
The buyer is also obligated to make a small one-time payment on the home, often called an "option fee." This is usually in the 1% - 3% range of the overall value of the home. The option fee and rent credit go towards the down payment but are not returned if the buyer doesn't go through with the purchase.
Risks For Buyers:
- No guarantee the buyer can actually afford the home at the end of the agreement—down payment contributions still might not be enough for mortgage approval
- Lose option fee and all rent credits if you don't buy at the end of contract
- Buyer becomes responsible for all problems with the home, including general wear and tear, repairs, upgrades and appliance replacements
- House can go into foreclosure if seller fails to make mortgage payments
- Missing a payment, even by a day, often forfeits that month's credit
- If house values drop, buyers are still locked in at the original price
Risk For Sellers:
- Seller is ultimately responsible for ensuring mortgage is paid on time, even if buyer misses or is late on payment
- Buyer can walk away at end of contract, leaving seller on the hook for the remaining mortgage
- If house values rise during the contract period, the seller can't accept a higher offer
Before entering into a rent to own agreement, both the buyer and seller should hire experienced real estate attorneys and financial advisors. The details of the rent to own contract will have implications on both the buyers and sellers for the entire duration of the rent to own period, and should not be taken lightly.
A successful rent to own contract resolves the different needs of both parties involved, and usually consists of:
- A seller who can't afford the mortgage but has been unable to sell the home at their desired price
- A buyer who doesn't qualify for a mortgage at this point in time but is likely to be approved in the near future
Whether a rent to own home is a good idea depends on the people involved and their specific situation. If a buyer is strapped for cash, has poor credit or doesn't manage money well, a rent to own option probably isn't a good idea for him or her. It won't resolve the issues that are causing the financial distress and the buyer is out of luck if she doesn't qualify for the mortgage at the end of the rent to own contract.
It's also important to recognize that the buyer isn't actually getting a discount or earning extra money towards the home. All of the credits contributed to the home are being paid above and beyond the regular rent. Unless there's a reason to lock in on this particular home right now, a buyer is just as well off renting elsewhere and saving the extra money in a bank account. In fact, mutual funds and investments often make this alternative more lucrative.
A rent to own home is a legitimate form of real estate but it carries some serious risks, which often outweigh the rewards. Evaluate your situation carefully and consider all of your options before deciding whether renting to own is a good idea for you.