How to Rent-to-Own a House
In 2019, there were about 128.58 million homeowners in the U.S, which is a significant spike from the 52.8 million homeowners in 1960. While these numbers are impressive, Americans are finding it harder to own a home today than their parents did a generation prior, largely due to affordability issues.
Rent-to-buy homes can be a more affordable path for prospective buyers. If you’re interested in the process, read on to learn how to rent-to-own a house, so you can know all of your options while house hunting.
What is rent-to-own?
Rent to own, also known as “lease to own” or “rental purchase,” is an agreement between a homeowner and an aspiring buyer in which the buyer agrees to rent for a given period before they’re given the option of buying the home outright. Rent-to-own contracts are alternatives to traditional loans. They give the renter the exclusive rights to purchase the property at some point in the future. Depending on the specific legal agreement you sign, you may be required to pay a one-time fee when renting the home. Part of the money that’s paid upfront (more on that later), as well as a portion of the specified monthly rent, goes toward paying for the house.
How does a rent-to-own agreement work?
Lease option agreement vs. lease purchase agreement
With a lease option agreement, you have the right but not the obligation to buy the home once the lease expires, meaning you can decide whether or not to buy the property. For this option, you’ll make a non-refundable payment at the beginning of the lease term. Option fees are negotiable and vary from lease to lease but will usually be between 1% to 5% of the purchase price of the home. The money will go toward the purchase price if you choose to buy it. You will have to forfeit the option fee if you decide not to go through with the purchase.
On the other hand, under a lease purchase agreement, you’re obligated to purchase the home at the end of the lease term. With this option, there are pre-agreed details such as the date of purchase, and when the purchase price will be established.
Mostly, rent-to-own agreements will state how the purchase price will be determined. You can negotiate with the landlord to agree on the purchase price. You set the price when the contract is signed, in which case, the current market value of the property will inform the price. Alternatively, you can decide purchase price when the lease expires, based on the market value at that time.
When renting a rent-to-own home, you may be required to pay a one-time, non-refundable fee. This fee, which is usually between 1% to 5% percent of the purchase price, gives you the chance to buy the home in the future. There is no fixed amount, and the option money can go into buying equity in the home. Make sure you understand the terms of the option fee in your contract.
The rental agreement will outline the plan to purchase the home. When you sign the agreement, you’re committing to pay a certain amount of money every month. This amount will cover both the rent and down payment savings, meaning it will be higher than the standard rent price. The down payment savings will be paid upfront to your mortgage lender in order to secure the amount you want to borrow. You can negotiate these monthly payments to arrive at a mutually agreeable figure.
The seller and the aspiring home buyer will agree on the rental duration and include the details in the contract. This period is between one and three years, with the goal being that the buyer will be in a financial position to purchase the home when the period lapses. What happens after the rental term expires will depend on the type of legal agreement signed.
Both you and the landlord will want to keep the property in good shape. Rent-to-own homes present a unique situation where the maintenance roles have to be clearly defined in the lease agreement. It’s important to understand who will be responsible for costs such as property taxes, HOA fees, maintenance, and repairs during the rental term.
Who is a rent-to-own home best for?
As home prices continue to rise in many cities, it is becoming increasingly difficult for many people to obtain financing to purchase homes. For aspiring homeowners who aren’t ready financially, a rent-to-own agreement offers a great option.
During the rental term, you will have a chance to organize your finances, save for a down payment, and improve your credit score. If the option money you pay upfront when renting the home offsets the purchase price, you’ll also build some equity. The advantage is that as you do all this, you retain the right to purchase the property.
How to rent-to-own a house in five steps
Here are some steps you may want to follow before you sign any paperwork.
Step 1: Get pre-approved for a mortgage.
Regardless of the legal agreement you have with the seller, there will be consequences if the lease agreement expires, and you’re still not able to purchase the property. Shopping for and getting pre-approved for a mortgage will make your work easier when purchasing. You’ll also be in a better position to know how much of your monthly payments should go into saving for your down payment, allowing you to plan better.
Step 2: Have a real estate attorney on standby.
A rent-to-own contract is a legal agreement. Consider having a reliable and experienced real estate attorney on standby. The legal expert will advise you on how to go about the process and protect your investment.
Step 3: Find your home.
Renting-to-own is just as big a decision as buying a home. You’ll need to find a home that meets your lifestyle needs and is within your budget. When looking for a home, you should consider the loan amount you qualify for.
Today, there are a number of sites that feature rent-to-own homes. Browsing these sites and using professional real estate agents will make it easy for you to find your dream home. You can also consider finding homes that have been on the market for a while and approach the seller to see if they’re agreeable to a rent-to-own situation.
Step 4: Negotiate the terms of the rent-to-own contract.
Next, obtain and review the rent-to-own agreement. Read the fine print carefully to make sure it’s a lease-option contract. Also, confirm that the contract defines maintenance roles, the portion of rent that will go toward the down payment, the rental term, the option fee, and purchase price.
If you’re uncomfortable with any of the terms, ask the landlord if they’re willing to negotiate. Take your time to avoid making mistakes that will cost you in the long run.
Step 5: Before you sign anything, run it by your real estate attorney
Before committing, get your real estate attorney to review the terms of the contract. An expert will better understand the terms used in the contract and can advise you accordingly.
Working with an attorney will help you choose the right terms, understand your obligations, and protect your legal rights and interests, hopefully saving you from future issues.
The pros and cons of rent-to-own
Rent-to-own plans have numerous benefits. But it’s important to understand the risks involved.
The bottom line
Understanding the basics of how to rent-to-own a house and doing your due diligence is key to successfully acquiring a home under this arrangement. But the potential pitfalls have serious financial implications that can adversely impact your home-ownership dreams. If you decide to lease-to-own, have a real estate attorney by your side.