What Is Rent to Own?
Rent to own is a way to buy or sell something over time, giving the buyer an “option” to purchase at some point in the future.
Under a rent to own agreement, the buyer and seller agree to the possibility of a sale at some point in the future. Ultimately, the renter/buyer decides if the transaction will actually take place. In the meantime, the buyer makes payments to the seller, and a portion of those payments (usually) reduce the money needed to buy the house at a later date.
Why Sell With Rent to Own?
Sellers may benefit from rent to own arrangements.
More buyers: If you’re having trouble attracting buyers, you can also market to renters who hope to buy in the future. Not everybody has good credit and can qualify for a loan, but everybody needs a place to live.
Earn income: If you don’t need to sell right away and use the money for another down payment, you can earn rental income while moving towards selling a property.
Invested renter: A potential buyer is more likely to take care of a property (and get along with neighbors) than a renter with no skin in the game. The buyer is already invested in the property and has an interest in maintaining it.
How It Works
Everything is negotiable: A rent to own transaction, also known as a lease option, starts with the contract. Both the buyer and seller agree to certain terms, and all of the terms can be changed to fit everybody’s needs. Depending on what’s important to you (whether you’re a buyer or seller), you can request certain features before signing an agreement.
Advice is essential: Be sure to review any contract with a real estate attorney because these transactions can be complicated, and there is a lot of money involved. Rent to own deals are especially risky for buyers. Several scams take advantage of people with poor credit and high hopes of buying a home. Even with an honest seller, it’s possible to forfeit a lot of money if things don’t go as planned.
An option to buy: At the beginning of any rent to own transaction, the buyer pays the seller an option premium, which is often around five percent of the ultimate purchase price (although it can certainly be higher or lower). This payment gives the buyer the right or “option” — but not the obligation — to buy the home at some point in the future.
No refunds: The initial premium payment is non-refundable, but it can be applied to the purchase price (if the buyer ever buys the home, she won’t have to come up with as much cash). Larger option payments are risky for buyers: if the deal doesn’t go through for whatever reason, there’s no way to get that money back. The seller typically gets to keep any premium payments after a rent to own transaction ends.
Purchase price: The buyer and seller set a purchase price for the home in their contract. At some point in the future (usually between one and five years, depending on negotiations), the buyer can purchase the home for that price — regardless of what the home is actually worth. If the market value has gone up or down in the interim, this will affect the profit and/or loss to the buyer and seller.
Monthly payments: The buyer/renter also makes monthly payments to the seller. Those payments serve as rent payments (because the seller still owns the property), but the renter typically pays a little bit extra each month. The additional amount is usually credited to the final purchase price, so it reduces the amount of money the buyer has to come up with when buying the home. Again, the extra rent “premium” is nonrefundable — it compensates the seller for waiting around to see what the buyer will do (the seller can’t sell the property to anybody else until the agreement with the renter ends).
Maintenance: Everybody involved benefits from a well-maintained home, but who should pay? Your agreement should specify who is responsible for routine maintenance and extensive repairs. Some agreements say that anything under $500 is the responsibility of the buyer, but local laws can complicate matters (landlords might be required to provide certain amenities, even if your agreement says otherwise).
Rent to Own Pitfalls
Nothing is perfect, and that includes rent to own programs. These transactions are complicated, and both buyers and sellers can get some unpleasant surprises. A few examples are listed below, but the list of things that can potentially go wrong is much longer. Only a local real estate attorney can give you a good idea of what’s at stake in your situation, so be sure to visit with one before you sign anything.
Risks for Sellers
Slow money: You don’t get a large lump-sum, which you might need to purchase your next house.
Discovering flaws: Buyers may discover flaws that you never knew about using the home differently, and they may decide not to buy. You’re not trying to deceive anybody — it’s a defect that never came up under the previous living arrangement — but now it’s an issue and you’ll have to disclose it to future buyers or fix it.
Fixed Price: A lease option sets the price of the home at a certain dollar amount. This number is usually based on the market value of the home at the time of the lease signing. Renters who sign a rent-to-own lease when the housing market is depressed stand to gain substantial value, as they’ll have a chance to buy a home for much less than its value in the future when home values rise.
The fixed price of a lease option can also be a drawback in some cases. Whenever the renter enters into a rent-to-own agreement with home values at a peak, the cost of the home might end up being more than its value, causing the renter to abandon the lease agreement
For investment property owners, acting as a landlord with a rent-to-own lease opens the market to more potential tenants than would be interested in buying the home in a straightforward sale. Renters are likely to be individuals who could not afford a down payment or qualify for a mortgage. By paying off a portion of the home during the rental period, these tenants also supply more income than traditional renters would.
An Uncertainty of Affordability: Renting a home with an option to buy is no guarantee that the renter will be able to afford the home when the lease expires. The property owner and tenant will need to go through the entire home sale process, which includes the tenant qualifying for a mortgage to pay for the predetermined cost of the home. A loss of income or savings might prevent a tenant from purchasing the home, forcing the tenant to move out and the landlord to find a new tenant and repeat the process all over again.