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Most people purchase their home by taking on a mortgage. They make monthly mortgage payments until the home is paid off, then they own the home free and clear.
However, some people won’t qualify for mortgages. Their credit scores might be too poor to pass a mortgage application, or they don’t have the money needed for the down payment. For someone in this situation, getting a mortgage would be pretty tough.
While some find an apartment and spend the rest of their lives paying rent, there is another option towards ownership. Rent-to-own agreements allow people who lack the required credit and capital the chance to purchase the home at a later date while already living in it.
These people enter rent-to-own house agreements. Then, at the end of the rental period, they have the option to buy the home. Typically, this would end in the buyer reapplying for a mortgage and paying the seller for the house.
What is Rent-to-Own?
The concept is simple, but the contracts are relatively complicated. Rent-to-own house agreements include clauses for:
- Option fee
- Purchase price
- Maintenance Costs
The option fee is part of almost every rent-to-own agreement. The renter and owner agree on the fee the renter must pay at the beginning of an agreement. After paying this fee, renter is guaranteed to have the option to buy the house in the future.
The option fee is typically between 2.5 and 7 percent of the home’s purchase price. The fee is usually due in a lump sum at the beginning of the agreement. In some cases, renters might be able to spread the fee out over the course of several months.
While a clause for option money is the most common, some agreements don’t offer an option. Instead, the agreement requires the person to buy the home at the end of the lease, so instead of an option, it’s a requirement. Buyers should be cautious of such agreements because getting locked into buying a home down the road might not be an ideal situation.
>> Read more: ZeroDown Rent-to-Own Mortgage Review
The buyer and seller might also agree on the purchase price of the house when creating the agreement. If so, the price is included in the agreement, and the renter has the option of buying the property at that set price when the agreement is up.
If the price is not determined, the agreement needs to explain how it will be determined in the future. For instance, it might be based on market value and appreciation.
If buying the house is in their best interest, savvy renters should do their best to lock in the purchase price in the initial contract. Home values typically increase, so buyers can get a better deal by locking in the price years before purchasing the home. However, owners aren’t always willing to do that.
Just like with any rental property, the renter must pay a set amount of money every month. In some cases, all the rent money goes to just rent, and none of those contributions go towards the purchase price option.
In other cases, monthly rent payments could partially contribute to the asking price of the home. This allows the potential buyer to earn some credit to put toward the purchase of the home when the rental agreement is over which is more in line with a typical mortgage
The rental agreement typically runs between one and three years, although people might decide to rent longer than that.
Some owners handle maintenance themselves. Others require renters to take care of maintenance costs. They also might require the renter to pay property taxes, homeowners association fees, and other fees incurred from owning the property.
Benefits of Rent-to-Own
Aside from being able to live in a house, there are a couple of benefits to rent-to-own house agreements.
The first benefit of a Rent-to-own agreement is it allows people with bad credit the chance to buy property. They have the chance to save up money while renting with the locked in option to purchase a home.
It also gives them the option to lock in a purchase price, if the owner allows it. Locking it in early could be ideal since home values typically rise over time, depending on the area. Of course, purchase prices might actually fall when the future buyer is renting the home. That shouldn’t typically be a problem since most contracts give the option to back out of buying it. Just make sure you have that option.
Potential buyers can also test drive a home before buying it. They might realize they don’t like the home as much as they initially thought. They can back out of the deal later instead of getting saddled with a mortgage.
Drawbacks of Rent-to-Own
The first rent-to-own drawback would be if the potential buyer decides to walk away at the end of the agreement, they forfeit all the money spent on rent which is mostly likely greater than the average standard rental agreement. Additionally, they would lose any money invested into the property which is another factor.
Some people might have trouble fixing their credit during the rental term. If this is the case, they wouldn’t be able to purchase the home because they won’t be able to qualify for a mortgage, so they might feel as if they wasted their time.
Here’s a big one. The potential buyer also has no real control of the property. The homeowner might fail to make a mortgage payment or property tax payment and lose the home in the process.
>> Read More: How to spot a rent-to-own scam
Is It Worth It?
A rent-to-own agreement is a good option for those who want to own a home but don’t have the means to buy one right now. However, they should pay special attention to the agreement. They don’t want to be taken advantage of, so they need to be sure to read the fine print.
Those who enter into a fair deal can benefit from a rent-to-own agreement. They have time to build up their credit and save for a down payment. They might even put some money into the home during the process.
>> Read More: Rent-to-own alternatives
Author: Jeff Gitlen, CEPF®