For most of us, buying a home is no small feat. It can take years to save enough money for a down payment, and there’s no guarantee that your perfect home will be on the market at the very moment you’ve been pre-qualified for financing and are ready to take the purchase plunge.
Buyers with a limited or shaky credit history may face an even more arduous road to the closing table. Even if your monthly income is solid, lenders only have so much leeway when it comes to overlooking high amounts of debt, low credit scores, and patterns of missed or late payments.
Fortunately, creative solutions do exist for motivated homebuyers. In this piece, we’ll take a look at why a rent-to-own arrangement might actually be a viable option for certain types of renters, and we’ll share input from top real estate agents with decades of experience.
What is rent-to-own?
To briefly summarize, a rent-to-own agreement is a situation wherein a homeowner agrees to sell their house (or to offer the option to buy) to a renter after a certain length of time. This period is usually one or two years, but it can vary depending on the renter’s credit history and how close they are to eligibility for mortgage approval.
How does a rent-to-own agreement work?
As with most real estate contracts, specific rent-to-own terms may differ from one party to the next, but common stipulations include:
- The renter will pay a certain amount above and beyond monthly rental fees, which will be held by the seller to later apply towards the purchase down payment.
- The purchase price of the home is determined at the time of entry into the rent-to-own agreement.
- If the renter-slash-hopeful-buyer chooses to have a home inspection performed, this and subsequent repair or allowance requests may need to be carried out at the start of the agreement.
- The renter is often responsible for maintenance and repairs of the property from the date of move-in.
- There may be an additional fee or deposit that the seller keeps, regardless of contract outcome.
- The seller may have the right to keep a portion (or all) of the would-be down payment funds in the event of the renter failing to uphold their end of the agreement.
This may all sound a bit complicated — and rent-to-own agreements certainly can be — but outlining clear terms to which both parties agree to from day one can create a win-win situation for everyone involved.
Why would you want to rent-to-own?
Rent-to-own deals are not for everyone, but they can be a problem-solving option for certain buyers.
If you need to improve your credit…
For hopeful buyers whose credit history may have lenders feeling uncertain, the year or two spent renting your home can offer time to make significant improvements to your credit score.
And since there’s a legally binding paper trail, lenders may be able to take your rent-to-own agreement into consideration during your mortgage application process (assuming that you’ve been timely and paid in full on your rent every month, of course).
If you need to save for a down payment…
For some buyers, income and credit history may be in good shape, but a down payment is missing from the equation. Renting-to-own can offer an opportunity to get into the home you’ve fallen in love with.
Since a portion of your monthly payments will count toward the purchase of the property, rent-to-own can be a great option for renters who struggle to save money on their own.
If you need to reduce your debt…
Just as with improving a credit score, a rent-to-own scenario provides valuable time to help you improve your debt-to-income ratio (DTI). Lenders typically like to see a maximum DTI of 43%, including your mortgage payment, so your time spent renting is a great opportunity to focus on lowering your debts while simultaneously saving for your down payment.
If you know you’ll be in this home for the long haul…
Given the lengthy runway to purchase, rent-to-own is unlikely to be a good option for buyers who are only looking to stick around for a few years. If, however, you know that this home and neighborhood are where you’d like to live for the foreseeable future — factoring in job opportunities, school districts, quality of life, and so on — then the opportunity costs of rent-to-own may be worth your while.
There are ample pros and cons to this type of agreement, but, ideally, at least three of the four above variables should apply to you for a rent-to-own discussion to be on the table.
What to know before signing a rent-to-own agreement
Rent-to-own is sometimes referred to as lease-to-own, and you’ll likely encounter the phrases “lease option” and “lease purchase agreement,” too. The overarching premise is the same in that the tenant usually enters the agreement intending to buy the home, but there’s nuance that makes it important to differentiate between a lease option and a lease purchase agreement.
“Tenants have to understand that deposit money is deposit money, rent money is rent money, and option money is option money,” says Ed Kaminsky, a Los Angeles-based real estate agent with more than 30 years of experience.
If you’ve rented before, you know the drill: Before moving in, you pay a security deposit that you’ll get back after move-out, providing that you’ve paid rent on time and you’ve left the home in good condition.
Monthly rent is, well, monthly rent.
Option money, then, is the additional fee you’ll pay — possibly as a flat rate, but more likely as an additional fee above and beyond rent each month — to grant you the option to purchase the house. In short, you’re paying the homeowner to agree not to sell the property to anyone else for the duration of your rental term, at the end of which you can either choose to purchase or move elsewhere.
The option fees you’ve paid will, in most cases, be kept by the seller should you decide not to buy. If you do move forward with the purchase, that money may be applied as a down payment, depending on how your agreement is structured.
With a lease purchase, you’re committing to buying the house from the get-go. This scenario is perhaps the one that most people associate with the concept of rent-to-own, but if you’re moving forward with this type of agreement, it’s vital to sign on with confidence and know you genuinely want this particular home.
In either case, be absolutely sure that your rent-to-own contract spells out:
- What happens to your option or down payment fees in the event that one or both parties backs out of the agreement
- Who is responsible for the cost of home maintenance during your rental period
- What happens if you are late on rent (there’s a big difference between voiding the entire deal and losing a month’s fees toward down payment)
Seek expert guidance
Again, if this rent-to-own business sounds complicated, it’s not without reason. While most real estate agents do not specialize in working with rent-to-own buyers, if you can find an experienced agent to have on your side, they’ll help to make sure you understand what you’re potentially getting into.
If you can, taking the extra step of having a real estate attorney look over your rent-to-own agreement is always a smart move.
“I’ve seen a lot of people lose a lot of money with a rent-to-own situation.”
Fraudulent rent-to-own incidents can occur when a homeowner chooses to stop paying their mortgage once they have a contract in place, if the house is already in the process of foreclosure at the time of rent-to-own agreement, if they fail to disclose major issues with the property (think structural problems, water damage, asbestos, and so on), if there are years of unpaid property taxes, or any number of other shady circumstances.
“It’s normally the out-of-the-box scenarios where I’ve seen [rent-to-own] work the best and limit fraud,” says Griffin, citing unique commercial properties and homes that are difficult to finance traditionally.
Rent-to-own for mutual benefit
Often, there’s little incentive for a seller to go the rent-to-own route. After all, why take a year or two or more to sell if a capable buyer is ready and willing to close in 30 days?
“I think sellers are considering [rent-to-own] when they’re having a challenge selling their home,” says Kaminsky.
In slow markets (which has not been the case with 2020’s housing market!), or when aiming for a lofty sales price, a homeowner may feel incentivized to consider a rent-to-own agreement. If a buyer comes along who “is not so challenged by the price but is challenged by the timing because they’re just not really prepared,” says Kaminsky, then a rent-to-own deal may be just the ticket to satisfy everyone.
But, as Griffin warned, be mindful when eyeing a house that needs repairs or renovation. Rent-to-own can be an enticing option for sellers who don’t have the cash to bring a dated home up to demanding market standards, and when met with a buyer who may have limited purchasing power, pesky details like home inspections and cost of upkeep are easily overlooked in favor of signing on the dotted line.
A successful rent-to-own transaction will benefit both buyer and seller, yes, but neither party should blatantly take advantage of the other.
How to find a rent-to-own home
Finding a rent-to-own property can be tricky. Most sellers are hoping to be under contract as soon as possible after listing their home for sale, and offering a lease option is unlikely to be top-of-mind even for homeowners with tricky sales conditions.
As ever, a good buyer’s agent can help you find potential rent-to-own homes — or skillfully propose the scenario to an open-minded seller. You can also utilize programs like Home Partners, Divvy, or Verbhouse, which work with buyers to purchase a house on your behalf, or match you with a suitable property already within their network, and then lease it to you with a right to purchase when the option to officially buy becomes a reality.
These types of services can be an especially valuable option in areas where the cost of buying a home is prohibitive, as they offer more flexibility and protection than striking a deal on your own.
“[These services] are a safe way to be able to secure your price and work with a reputable company and not have to worry,” says Griffin. “It’s a safer option because the liability is less.”
Know rent-to-own is an option, but proceed with caution
Homeownership has long been a mainstay of the American dream, and sometimes it takes more than working long hours and skipping $5 lattes to be in a position to buy a house. There’s no shame in needing extra time to build your credit or save up a down payment, and renting-to-own can offer a valuable lifeline, especially if you’ve found a property that is perfect for you and your family.
While you’ll be hard pressed to find a real estate expert who advocates for any variation of a rent-to-own agreement as the most ideal purchasing scenario, take heart in knowing that the opportunity does exist and that, under the right circumstances, it can be a worthwhile pursuit.
If rent-to-own sounds like a path you’d like to further explore, do your research. Like any potential buyer, you should educate yourself on the neighborhood, property values, and your financing options. Start by talking to a lender to gain a full understanding of where you’re at in terms of credit and what steps you’ll need to take to work toward securing a mortgage, and don’t hesitate to reach out to an experienced real estate agent for their local expertise.
But do understand that expert advice may not always be what you’d like to hear.
“Rent-to-own is great if it’s a weird property, or if it’s not financeable, or if it’s some type of unique commercial space, but there’s so much liability,” says Griffin. “With what’s happening in our world with forbearance and foreclosures and unemployment, I would never encourage anybody to rent-to-own unless [the seller] has no payments due and is free and clear on their home.”
Header Image Source: (Jack Prommel / Unsplash)