The traditional idea that you need a down payment to purchase a home might go out the window with rent to own opportunities. Although this option might be enticing, there are some significant risks that you’ll need to be aware of.
Want to avoid expensive real estate mistakes? I highly encourage you to download a free Cheat Sheet to 9 big Mistakes Made in Real Estate Investing. You’ll learn what mistakes could cost you thousands.
So how does rent to own work? And is it right for you? Let’s take a closer look.
How does the rent to own process work?
First, let’s explore how the process of rent to own (or lease to own) opportunities work.
The lease agreement
As the buyer, you enter a lease agreement for a specific period of time. Whether you sign a lease agreement for months or years, you’ll make monthly rental payments to the seller. Each time you make a payment, the seller is obligated to set aside a designated amount of money which will be put towards the buyer’s equity in the home. If the buyer goes through with the home purchase, the monthly amount of money set aside will become a part of the buyer’s equity in the property.
When you sign up for a rent to own situation, there are two contracts you might encounter. You’ll sign either a lease option agreement or a lease purchase agreement. With a lease options agreement, you have the option to purchase the home at the end of the lease period. With a lease purchase agreement, you are required to buy the house at the end of the lease period.
As the buyer, you’ll need to be careful about which documents you sign. Make sure that you don’t lock yourself into an agreement that you cannot afford to honor. Beyond that, the buyer and seller will need to approach the process with a degree of flexibility. In most cases, there is a lot of wiggle room in the negotiations process for the rent to own process. Don’t be afraid to ask questions and negotiate along the way.
At the end of the lease agreement, you’ll need to transition from a rental interest in the property into the owner of the property. Although you will have paid the seller a non-refundable fee called option money, you’ll still need to secure long-term financing for the home purchase.
Once you secure the funding, the lender will set a closing date to finalize your official ownership of the property.
Want to eliminate your housing expense for good? Try house hacking! Learn everything you need to in our free Quick Start Guide to House Hacking.
What's the catch with rent to own homes?
Rent to own opportunities might sound like a good opportunity.
The biggest catch is that rent to own options are often more expensive than traditional homeownership options. With upfront fees and rent payments, it might not be as affordable as you think.
Although you won’t have to come up with long-term financing upfront, you’ll likely need the backing of a traditional lender at some point to finalize the purchase. With that, you might face similar hurdles in securing the funding if you start the rent to own process with bad credit and minimal financial resources.
Advantages and disadvantages of “Rent to Own”
Here’s a closer look at the pros and cons of rent to own agreements.
Pros of rent to own
First, let’s explore the pros.
- Down payment built over time. As you hand over rent payments, the owner will set aside a portion to create your down payment.
- Less competition. Many buyers are unwilling to consider rent to own options, which gives you more bargaining power.
- Delay the mortgage application process. If you cannot find a lender to fund a mortgage for you right now, rent to own can provide a delay. You’ll likely still have to apply for a mortgage with a traditional lender at some point, but you can take some time to boost your credit score.
- Move less. Can’t qualify for a mortgage right now but don’t want to move multiple times? Rent to own could play in your favor.
Although you might find more advantages in your unique situation, these are the pros that stand out.
Cons of rent to own
As with most financial decisions, there are some cons to be aware of:
- Expensive. You’ll have to pay more to own this own through rent payments and nonrefundable option money.
- Repairs. In some rent to own agreements, you might have to foot the bill for maintenance and repairs on the property while you are renting.
- Locked in price. This could go both ways. But if you lock in a purchase price and then prices drop, you could be stuck with an overvalued home.
- Seller could find loopholes. Rent to own contracts are often written in favor of the seller. With that, you might find yourself in an unpleasant situation if the owner is not working above board.
Unfortunately, there are many risks associated with this option.
Why would a seller rent to own?
As a buyer, the pros and cons are easy to see. But why would a seller want to pursue a rent to own agreement?
Sellers can view rent to own agreements as a reliable income stream as they sell a property they no longer want. Rent to own properties can attract more buyers that are left out of the traditional buyers arena. Beyond that, a rent to own agreement ensures that the seller has a motivated buyer with an interest in maintaining the property while living there.
Should you consider a rent to own property?
Rent to own is not the right fit for everyone. But that doesn’t mean that rent to own is the wrong option for everyone. The answer will depend on your unique financial situation.
If you are struggling to save for a down payment or qualify for a traditional mortgage, rent to own may be your only available path to homeownership. With that, it could be useful in some situations.
However, I would advocate for taking the time to build your financial foundation. Build your savings, boost your credit score, and seek out low money down loan options to provide homeownership opportunities with less risk and fewer expenses.
You can learn how to build your financial foundation with FI by REI.
The bottom line
Rent to own is an opportunity for some. However, there are many risks that you should take into consideration before moving forward.