Rent to Own Houses: How to Do It

How Rent to Own Works

Have you heard about the potential to rent to own a home? Lots of people wonder how rent-to-own purchases work. You have probably seen advertisements for rent-to-own properties at one time or another.

While these rent-to-own options are not standard, they appear occasionally and may appeal to you if you are not quite ready to buy a home traditionally.

But how do rent-to-own houses work? Are they a good idea? The more you know about rent-to-own arrangements, the better you will be at deciding if renting-to-own is the right fit for your real estate goals.

Quite a few folks try to decide between renting and buying a home. A rent house-to-own scenario can end up being the best of both worlds.

Let’s look at the pros and cons of renting to own both from the owners’ and tenants’ perspectives.

The Traditional Home Buying Process

For some perspective, we should first look at a traditional home purchase’s basics for comparison. Most homebuyers follow the same process when they buy a home. They hunt for a home that they like and then make an offer on that home.

Once the offer is accepted, the buyer typically engages with a professional home inspector and has the property inspected.

The home inspection is a great way to find out whether you are buying a lemon or not.

Once the home inspection is completed and wishes to proceed, a buyer will get a mortgage from their lender. When the mortgage commitment is in place, they pay the home seller at closing and obtain the title transferred from the seller to themselves.

Usually, a home sale takes between one and two months to complete when financing is involved. If the home is purchased for cash, it can take as little as a week or two.

Quite often, in a traditional home purchase, the buyer has been renting and decides that home ownership is the right move.

The Rent-to-Own Home Buying Process

When you rent to own a house, the home buying process stretches out over a much extended period. The buyer finds a property owner willing to enter into a rent-to-own agreement.

The buyer and seller negotiate an arrangement where the buyer can live in the home and pay rent for a specified period, with a portion of the rent going toward the house’s down payment.

At the end of the specified time period, the buyer will either have the option to buy or not buy or will be required to purchase the home (more on this later).

What Are The Monthly Rent Payments?

One of the key questions with own option properties is what the monthly rent payments should be. The monthly payments are usually at least what the market would be for a traditional rental property. It is possible that you could be required to pay more than the going rate for rent payments.

The amount that is higher than the normal monthly payments could go towards purchasing the property. This agreed upon portion of the monthly payments is referred to as the rent credit. We will get into this more in greater detail.

There is usually a Non-Refundable Upfront Fee

A lease-option agreement gives the seller a one-time, typically non-refundable, upfront money called an option fee. The options monies will allow you to buy the home in the future. The purchase option fee is negotiable but typically ranges between 1-5% of the home’s purchase price.

Who Pays The Property Taxes?

Another common question with own option homes is who pays the property taxes. The property owner is the party that will pay for property taxes. A potential buyer does not pay for this expense until the lease ends and they become the homeowner.

Why Would Someone Rent a House to Own?

Many people wonder if renting to own is a good idea. It certainly can be in some circumstances. Not everyone is ready to buy a home. You must have good enough credit to get a mortgage and an adequate down payment. If you have bad credit but are working towards repairing it, it could work out well. A low credit score is a common reason why someone will look for rent to own houses.

In most cases, you have to come up with a down payment unless you are a veteran who can procure a Veteran’s mortgage or buy in a rural area and get USDA financing. Finding a house for low income can be challenging sometimes, and rent-to-own homes can satisfy that need.

When purchasing a home for the first time, it is essential to brush up on the financing programs available for first-time homebuyers.

These are financial hurdles that may take time for you to overcome. But if you know you want to be a homeowner or at least like to have the option in the future, you could find a rent-to-own deal and start down the path towards your goal.

Maybe you have identified a home you’ve driven by quite often and always loved. Perhaps you also have found out the owner is up in the air about selling or renting. In this situation, a “rent to own” could be the best of both worlds for you and the owner.

Whether you buy now or in the future, brushing up on essential first-time homebuyer tips is vital, so you don’t make one of the more common mistakes.

What You Need to Pay Attention to With Rent-to-Own Houses

There Are No Hard and Fast Rules With Rent-to-Own Homes

Unlike traditional real estate transactions, rent-to-own arrangements are more personalized and flexible. This can be a good thing or a bad thing. It can be a good thing when you arrange with the seller what is fair and beneficial to you.

It can be harmful if you ignore the contract you sign—because you can quickly get into a deal with unfavorable terms where you see little to no benefit, and the seller sees all the positives. The “own option” can be great, but not if the terms are one-sided.

You will need to negotiate a leasing-to-own contract.

All real estate transactions involve contracts, and rent to own is no exception. It would help if you did your homework to understand what should be included in the contract and what the terms should look like.

You are negotiating a business deal, so you need to be careful. It is an excellent idea to hire a real estate attorney to review and explain the contract so you avoid entering into a deal you do not understand.

Know The Rent to Own a Home Contract Terms

For rent-to-own houses have specific contract terms that you need to pay attention to. These include:

The Lease Term

The lease term defines how long the lease will last before you need to buy the home or move out. You and the seller can agree to any lease term you like.

Most rent-to-own lease terms range from one to three years. Be realistic about how long it may take you to get ready to buy—including repairing your credit and saving up for a down payment. A one-year lease term may not be long enough for you to get your finances in order.

The Option Fee

The option money is the fee you will pay the seller for the option to buy the home. The option fee is usually something you can negotiate. Typically, the cost will range between 1 percent and 5 percent of the home’s purchase price, although it can be lower or higher depending on your circumstances.

Sometimes, the option fee can be applied to the house’s purchase price, depending on your negotiation with the seller.

Lease Option or Lease Purchase

You have two options regarding a rent-to-own agreement—a lease option or a lease purchase. You want to be confident in what your contract says here because there is a big difference between the two.

A lease option means you will have the right to purchase the home at the end of the lease. You can buy or not buy it. A lease-purchase agreement means you are legally obligated to buy the house at the end of the lease.

A lease-purchase agreement will put you in a challenging position if you do not have the financial means to buy the home or do not want to buy the home at the end of the lease. When trying to rent to own a house, these are critical terms to master.

What is The Rent Credit?

It is standard for some portion of your rent to go towards the home’s down payment when you rent a home to own. Usually, the rent credit ranges between 10 percent and 25 percent, but again, it all depends on what you negotiate with the seller.

There are no hard and fast rules for the rent credit. It would be best if you insisted that the rent credit is kept in an escrow account to protect you and the seller.

Usually, the rent will be a little more than the going rate for the area to compensate for your rent credit.

What is The Home’s Purchase Price?

Some rent-to-own agreements establish the purchase price when the contract is written at the beginning of the lease. Other agreements state that the fair market value will be determined at the time of purchase. Either way, you want the decision on the purchase price in the contract.

Who Takes Care of The Home Maintenance?

You can negotiate who is responsible for property maintenance, everyday maintenance like mowing the lawn, and significant maintenance like replacing the roof or the HVAC system. Primary care is expensive, so be careful about what you agree to. Either way, you should get a home inspection before signing the agreement.

Leasing to Own: Pros and Cons For Buyers and Sellers

In most leasing-to-own situations, most advantages are on the homeowner’s side. However, there are still some advantages for the renter turning home buyer.

Pros For The Seller With Renting to Own

A buyer’s real estate market can be an excellent opportunity to increase cash flow from renting a property that was otherwise vacant or difficult to sell.

Most rent-to-own arrangements are long-term, and the rental rate can be higher than average, an advantageous arrangement for property owners.

Pros For The Buyer With Renting to Own

Rent-to-own agreements essentially allow buyers a few years to improve their credit score and save additional funds for a down payment.

If a lease option to purchase agreement has the house’s selling price, that price is locked in even if real estate values go up.

Cons For The Seller With Renting to Own

You will not be able to sell the house if the real estate market improves and you are still within the contract terms. If the agreement includes the sales price, you will not be able to raise the price.

It is possible that home values could have gone up quite a bit from the time you agreed on a sales price.

If the buyer backs out and doesn’t improve their credit, you’ll return to the drawing board and be stuck with a vacant rental.

Cons For The Buyer With Renting to Own

If you still have bad credit and don’t increase your credit score, you could lose the option fee and the years of extra rent paid. Also, something out of your control could happen, for instance, a job loss or a severe illness that could prevent you from buying.

It is possible you could also find yourself hooked up with a shady landlord who scams you out of money.

When renting to own, you’ll be paying more than necessary each month with a promise from the landlord that they will credit that amount toward your purchase in the future.

As you can see, there are pros and cons with renting to own for a buyer and seller.

What Can Go Wrong in Rent to Own Option Arrangements?

Besides the above pros and cons of rent-to-own agreements, there are other things you should be cautious of both as an owner and a renter. Here are some considerations to think about before entering into one of these agreements:

• The house owner doesn’t pay their mortgage or taxes, putting themselves into the position of being foreclosed on.
• The renter doesn’t treat the property as well as you do – letting all of the maintenance go, devaluing the property.
• While living in the property, the renter discovers problems that make them not want to move forward.
• The owner passes away before the completion of the agreement complicating the transaction.
• The contract is terminated because rent is consistently paid late, and the renters lose their investment.
• It’s possible a homeowner could try to sabotage the agreement so that they can sell their property for more than the stated contract.

While these are the “worst of the worst” things that can happen, it’s always essential to have them on your radar, whether you are the buyer or seller.

Avoid Lease Purchase Agreements

There is a lot of flexibility in rent-to-own agreements—you and the seller can find terms that you both think are fair. But of all the terms you should avoid, lease-purchase contracts are the most important.

It is not a good idea to lock yourself into a purchase that won’t occur until years later. Many things can change, including your financial situation, so steer clear of lease-purchase agreements if possible.

FAQs With Rent-To-Own Homes

1. What Credit Score Should You Have When Renting to Own?

You will want to shoot for the highest credit score you can get. The better your credit score, the better mortgage terms you’ll receive when it comes time to buy. The minimum score you will want to have is 620, as getting a loan will be far more challenging when it is lower.

2. Can I Rent-To-Own a Home With Bad Credit?

Yes and no. You might be able to find a landlord who will rent to own a property with bad credit, but you’ll need to improve your score to get a mortgage with a traditional lender. Remember that many homeowners won’t rent to you with bad credit, so don’t bank on it.

3. Could a landlord break a rent-to-own contract?

Yes, and this is very important to keep in mind. The agreement states that you must pay your rent each month as a tenant. If you breach the contract, the landlord could have a right to terminate and evict you.

4. Is Renting-to-Own Cheaper Than Renting?

The difference between a traditional rental and how renting to own works is the money going toward the down payment with rent-to-own agreements. You are essentially building some equity with a rent-to-own arrangement.

5. Is Rent-to-Own Better Than Buying?

The better question would be, is renting better than rent-to-own? In most circumstances, no. People who make rent-to-own contracts do so because they cannot purchase a house.

6. Is it Better to Own or Rent?

This question has been debated over and over again for many years. There is no right or wrong answer, as much depends on timing. Are home prices going up or down? Are interest rates high or low? Can you rent and invest the savings in rental costs vs. a home purchase and come out ahead? These are all questions that need to be answered in order to determine the better option at the time.

7. Will a Bank Do Rent-to-Own?

No. Banks that foreclose on an owner have one goal in mind – to get the home sold quickly. Banks have no interest in being landlords. Banks want their REO properties liquidated for as much money as possible in the shortest period of time.

8. Can I Renovate a Rent-to-Own House?

Yes – If the rent-to-own agreement has a lease option clause and language, you can make renovations and other improvements. You would not be able to renovate a home without a lease option agreement.

9. How Long Are Lease-to-Own Contracts?

More often than not, they are one to three years in length.

10. Can an Owner Back Out of a Rent-to-Own Contract?

No. Once both parties have ratified the contract, neither party can back out without legal ramifications. If an owner tried to back out of a lease-purchase-agreement, they would not have the authority to sell the property.

11. Can a Realtor Help Me Find a Rent Home to Own Option?

Yes, although many real estate agents do not get involved with rental property and strictly deal with home sales. Some real estate agents might not be motivated to deal with this kind of transaction as they would not get paid a commission for a much more extended period of time.

Final Thoughts on Renting to Own

Rent-to-own transactions are not commonplace, but they can sometimes work when two parties have unique circumstances. Just be sure you go into a lease-to-own option with eyes wide open. Understand the advantages and disadvantages before making a long-term financial commitment.

Hopefully, you now understand how rent-to-own works and make an informed decision based on all of the pros and cons of a landlord or renter.

About the author: The above Real Estate information on how rent-to-own homes work was provided by Bill Gassett, a Nationally recognized leader in his field. Bill can be reached via email at billgassett@remaxexec.com or by phone at 508-625-0191. Bill has helped people move in and out of many Metrowest towns for the last 35+ years.

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