Is "Rent to Own" a Safe Option for First-Time Homebuyers?

Since last year, news of housing markets has centered on low inventories and rising prices. But, an often-overlooked option to down payment and affordability challenges is "rent to own." This involves renting a home for a predetermined period, such as three years, and then buying the home at a predetermined price. Homeowners who have had problems selling, and investors in single-family rentals, often use the rent-to-own option.

Since last year, many first-time buyers have faced unemployment, underemployment or layoffs. They've had to stop saving for down payments or delay getting them started. Many have even raided their down payment savings to pay their monthly bills. At the same time, starter homes have been become scarcer than ever.  By the third quarter in 2020, as millions of families were struggling, median existing single-family home prices had risen by 12% year-over-year. Coming into 2021, the higher price tags don't look like they'll be coming down in the near future.

Buyers pay monthly rent amounts that are higher than the market, and the premium is credited toward the house purchase. This reduces the amount the buyer must pay when the rental period ends. Usually, the size of the premium ranges from 15% to 25% of the rent price.These renters also pay an option fee when the contract is signed. Option fees average about 5% of the purchase price. Option fees are held in an escrow account until the buyer purchases the property, and buyers can have the option fee applied to the sale. Should they miss a rent payment for any reason, they lose the right to buy the house. Option fees and premiums are not refunded.Buyers can purchase the house for the agreed-upon sale price at any time during the term of the lease. If sellers want to sell the house before the lease period expires, they must offer it first to the buyer at the contracted price. If the renter cannot buy, or decides not to, and the house is sold to another party, the renter might lose the option fee and premiums unless the lease contract protects him or her. 

Buyers struggling through the pandemic with marginal credit scores, too little income and too much debt can buy some time to improve their financial condition by renting to own.  First-time buyers stuck in a high-priced market might be able to afford a more expensive home by renting to own.Sellers who've had difficulty attracting interest but don't want to lower their sale price could be better off by offering the option of a rent-to-own deal. Renting to own is also attractive to investors in single-family rentals. They can line up a tenant and a higher sales price years in advance and never risk a vacant month. Premium-priced rents are an easy way to improve cash flow.Renting to buy has also has drawbacks. Any buyer who might need to move within the lease term shouldn't consider it, nor should anyone who can qualify for a mortgage on attractive terms at today's super-low rates. From a macro perspective, rent to own plays a useful role in stabilizing housing markets under pressure by providing an alternative to a traditional sale. During the pandemic, barriers to homeownership have grown. Though mortgage rates are at historic lows, lenders have raised approval standards, especially for self-employed and "gig" economy workers. 

Unfortunately, the history of rent-to-own is a checkered one, tarnished by unscrupulous owners who took advantage of families who did not do their research. Some examples of scams:

• Sellers who falsely present themselves as owners of the property
• Unpaid property taxes that buyers don't discover until they are renting
• Properties with mold, lead, asbestos, or other health or safety issues
• Sellers with inadequate insurance to cover fires and floods
• Pending defaults and foreclosures that the buyer doesn't learn about until it is too late
• Sellers who disappear with buyers' option fees or go bankrupt before the property is sold

"Even with legitimate rent-to-own deals, the devil is in the details," cautions Amy Hebert, a Consumer Education Specialist with the Federal Trade Commission. "You might have to pay upfront fees and higher monthly payments than if you were renting. In some deals, if you miss a payment, the deal is off. If you do make it to the end, you might find you're locked into paying more than the home is now worth, or that you can't qualify for a mortgage to finish paying off the house."When considering a rent-to-own deal, buyers should understand their obligations and retain a real estate attorney to review the contract and check out the seller.

If you're interested in exploring renting to own, check out the Homes.com Search Page. Enter the ZIP code you want to search, and click on "Rent" to see listings of rentals in your neighborhood. Click on any of the listings, and a blue button that says "Search for Rent to Own" will take you directly to rent-to-own properties in your market.