You see these signs all the time, especially at large intersections: “Rent To Own! No Financing Necessary!” While I’m familiar with rent-to-own (or lease to own, as some call it) when it comes to appliance and even car purchases, I’ve always wondered exactly how this works with a house. I did some digging recently, and here’s what I found.
The basics
Renting to own a home is somewhat similar to a car lease. The seller has given his tenant the right to buy the house at some point in the future, usually one to three years out, for a price that is agreed upon today.
Generally, the tenant will pay a fee, called option money, that will keep open the option of buying. In addition, it is common for the tenant to pay about 20 percent above the typical rent for the house. So if a home were to normally rent for $1000/month, a rent-to-own tenant would pay $1200. A portion of that rent will be credited to the tenant for an eventual down payment.
This can be a win-win for both seller and tenant. Many sellers offer this option if they are having trouble unloading the house and can no longer afford the mortgage payment. Often, you will find that sellers offering rent-to-own as an option are individuals who have already moved into a new home and are trying to avoid paying double mortgages for the long term.
Tenants who rent-to-own are often individuals who would have trouble buying a house through the traditional route because of poor credit, low income, or lack of a down payment. Rent-to-own gives them an opportunity for home ownership while living in the house they will eventually purchase and it also gives them a chance to discover flaws in the house before committing to purchasing it.
The fine print
Unfortunately, rent-to-own is not always a good deal. If the tenant decides not to purchase the house at the end of the rental term, none of the extra money that he paid to the seller comes back to him. So he would have paid above market value for a rental and have no extra cash to show for it.
Furthermore, unlike in traditional rental scenarios, the tenant is often responsible for repairs and maintenance during the lease term, and any money or sweat equity you put into the rent-to-own property will not be reimbursed.
Finally, some rent-to-own agreements are worded so that you are contractually obligated to purchase the home at the end of the lease. It’s extremely important that you know exactly what you are signing if you enter into one of these agreements so that you are not stuck with a contract you cannot fulfil.
The pitfalls
It turns out that many tenants who enter into rent-to-own agreements end up unable to buy the house at the end of their lease for the same reason they were unable to buy before: they still don’t have the credit rating, the income, or a large enough down payment. At that point, the seller walks away with a great deal of extra cash toward his mortgage and the tenant ends up with nothing.
If you are interested in a rent-to-own agreement, it would make sense to talk to a bank about financing before you sign any papers with the seller. Ultimately, however, these agreements are not the healthiest financial path to home ownership.
