With home prices and down payments on the rise, many prospective homeowners are finding a different path to homeownership. Some homeowners and landlords offer “rent-to-own” arrangements where tenants can buy the homes they are renting after a period.
A rent-to-own contract requires a prospective buyer to pay monthly rent to the homeowner plus a payment towards purchasing the home at a later date, usually three to five years in the future. The purchase price is set in advance.
For example, a house could be rented by its owner for a standard rent of $1,750 per month. But when negotiating the rent-to-own contract, the buyer and the homeowner can agree that that the buyer will pay $2,000 a month, with $250 as a home buying credit. At the end of a three-year lease, the buyer will have set aside $9,000. The amount of money that was set aside is returned to the buyer at the time of settlement and can be used for an earnest-money deposit, a down payment on a mortgage or closing costs.
Should the renter decide not to buy the property, they will probably not be able to recoup the amount that has been set aside. If a tenant is not sure is that they will want to buy the property at the end of the term, they might propose two separate contracts- the land installment contract and the lease with option to buy.
Is renting to own for everyone?
Rent-to-own deals make more sense for buyers who have a hard time saving for a down payment or who have marginal credit. For example, many families who lost their homes to foreclosure have found that rent-to-own properties help them re-establish their credit and accelerate their return to homeownership.
Also, buyers who rent-to-own won’t have to move to become homeowners. They know the property and the neighborhood where they are buying, and they won’t encounter any surprises when they assume ownership.
On the other hand, buyers who go the rent-to-own route may find that they agreed upon a price more than the house is worth when the time comes to buy it. They might find that they would have been better off saving or investing the extra amount they paid every month and using the savings to make a down payment on the home of their choice.
Sellers who rent out their homes to buyers may find that they have to take a greater risk that normal by leasing to someone with less than stellar credit. They can structure the deal to make a profit, but if they are greedy, they will drive away responsible tenants. Finally, it can be difficult in today’s real estate markets to accurately forecast the value of a home three to five years in the future, and owners run the risk of pricing their home for less than it might be worth in an active market.
Reasons for concern
Buyers considering a rent-to-own relationship should do their due diligence on the owner and the terms of any contract they are asked to sign. In recent years, lenders seeking to unload foreclosed properties and investors seeking big profits have structured rent-to-own deals to profit at the expense of prospective buyers, who don’t enjoy the protections of state tenancy laws.
A recent investigation by the New York Times found that “Most tenants walk away with nothing, having sunk money for rent and repairs into homes they had once hoped to own. Others faced surprise evictions, having signed a contract that did not disclose what repairs were needed, yet set a deadline for making sure the home was up to local housing code. As different tenants move in and out of the same property over the course of years, many homes fall further into disrepair.”
Consumers considering a rent-to-own contract should take steps to protect themselves:
- Do the math. Calculate the total amount you will be required to pay by the time you can buy the house. If you invested it for the same period at 4 percent appreciation, how much more would you have?
- Check out the marketplace rents. Is the monthly rent you are being asked to pay more than other local properties? Surf some rental sites to check out rental rates. Does the rent rise every year? Is the increase fair?
- Is the purchase price reasonable? Look up the price that similar homes (same area, the same number of beds and baths, same age) are selling today. How much are home prices rising in your market? Is the sale price of the home you are considering much higher than what it looks like it will be worth at the time you buy it?
- If you are renting/buying from a lender or investment company, are they financially viable? What protection would you have if they went bankrupt or sold off the property you want to buy?
- What protection do you have if you should encounter a financial reversal, bad health, or another problem beyond your control that could force you to back out of the agreement?
- Should you make a late monthly rent payment, would you forfeit the money you have paid towards buying the home?