Rent-to-own is an alternative to the traditional agreement between homebuyers and sellers. Typically, a buyer presents an offer. Once accepted, the payment, settlement and new ownership takes place. Lease-to-own or rent-to-own does not follow this process. Instead, it allows a renter to become the buyer. This is done through another type of contract agreed upon by two parties.
What Is Rent-to-Own?
The details of a rent-to-own may vary. Usually, the term refers to a scenario where the owner promises to sell their property to the tenant for a specific price, within a certain period of time.
To this end, some contracts do not obligate the tenant to buy the property when the lease is up. They might simply give them the right to consider it. Of course, words matter, which is why the contract needs to be properly negotiated—often by a real estate lawyer.
Potential buyers get to move into the house right away, even though they do not own it yet. Because of this, the buyer/renter still needs to get renter’s insurance. Also, if stipulated, the potential purchaser may need to maintain the dwelling, undertake repairs and anything else agreed upon in the contract.
Not Your Ordinary Lease
Any lease is a contract, but the rent-to-own lease may have very different provisions in it. Some of these are dictated by state regulations, and others are stipulated by both parties. Thus, certain conditions and terms must be met to honor the contract. But there are many variables.
Often, a portion of the monthly rent payments is allocated in the form of a credit, either toward the purchase price or closing costs that the buyer incurs. Also, the potential buyer usually pays the seller an arranged, and often non-refundable, fee called “option money.” Since there is no standard for this, that amount could range between 2.5 percent and 7 percent of the asking price.
In terms of the actual purchase price of the property, this is also clarified in the contract and may be locked in at the outset of the arrangement. If the buyer does decide that “Yes, we want this house,” they typically apply for a mortgage to finance it and pay the seller in full. Per the contract, some of this money will have been paid through rent and the option money.
Is Renting to Own Right for You?
Renting to own could work for a potential buyer who is trying to improve his or her credit score, has some debt or can’t get a great mortgage. Of course, you have to do the math to see how things add up. Remember, if you don’t end up buying the property, the non-refundable option money and rent payments are in someone else’s bank account now.
For the seller, the idea of renting to someone who is excited about your house could work for you too. Maybe you already found house No. 2 and haven’t found a buyer for this property yet. A lease-to-own option will take your old home off the market, and give you that locked in price after the lease period is up. It may be worth your while with folks you deem ideal buyers.
4 FAQs About Renting to Own
There are pros and cons to every situation, and rent-to-own is no exception. Greg Roth, loan officer for Approved Mortgage Group (AMG) in Center City, Pa., had answers to these four frequently asked questions:
How do you finance a rent-to-own? Do you go for a mortgage first and then approach the seller?
When you do a rent-to-own, you are still technically a renter until the day of the actual purchase. The lease agreement is just a bit more extensive in that it contains verbiage regarding the right to purchase. Only money paid monthly over the fair market rent amount can be considered as part of a down payment for the purchase. Example: If the rent for the property is $1,000 per month but the renter pays $1,500 per month, the landlord would hold the extra $500 aside each month and it would be counted toward a down payment when the purchase takes place. So, if you rented for 12 months, that $6,000 would go toward the down payment on the home.
Is rent-to-own something that prospective homeowners should think about? For instance, let’s say a seller has already bought a new home, but has not yet sold the last one. Does it make sense for them to do this?
This could certainly be a good tool for them to collect some rental income and get the home sold at the end of the lease. This would be a situation of seller preference on a case-by-case basis. Typically, this might be a situation to use if they are having trouble selling the home and they have good renters that have disposable income, but need some time to work on their credit to qualify for a mortgage.
For first-time owners who have cash flow, but lack a huge down payment, is it something to bring up to a seller?
This could be an option, although in some price ranges most sellers will be hesitant to do a lease-to-purchase.
Does a rent-to-own go through a REALTOR® and mortgage broker, or is it just a legal contract that the seller and buyer draw up through a lawyer (who has knowledge about that specific state)?
It can certainly be done with a REALTOR® or a lawyer. Again, it is the preference of what makes the parties most comfortable. As it is a more lengthy and in-depth commitment, I would suggest a REALTOR® set up the contract and then have a lawyer review it.
Seal the Deal
There is much more to learn about a lease-to-own property besides these tidbits. Both parties have to do their due diligence, crunch numbers and see if it is even feasible. Happy house hunting!