I’ve been renting for over a decade.
And I’m getting kind of tired of it.
But what if my credit isn’t as good as it could be and I don’t have the savings needed to cover a down payment? Do I have any options?
Yes, there is rent-to-own.
Rent-to-own is a viable option for people that are looking to plant their roots but can’t take on a mortgage.
So how does rent-to-own work? Typically, a rent-to-own arrangement occurs when a tenant signs a lease with the option to buy the property later. These leases are usually three-year agreements, and the tenant pays rent along with an additional payment that goes towards the down payment of the house.
Think of it as higher rent that turns into a mortgage later.
Let’s get down to the nitty-gritty of this type of arrangement because this decision has long term consequences.
What it Means to Rent to Own
When you sign a rent-to-own agreement, your monthly payments will consist of two things.
- The typical market-rate rental payment. In other words, the amount of money you would usually pay if you were renting the property.
- An additional payment each month that goes towards your down payment for when you’re ready to buy the home. Your lease should list the rental amount, how much of that payment goes towards the down payment, and the projected selling price.
Basically, you’re paying rent and a portion of the down payment every month.
The Process for Rent to Own
There are two variations to the rent-to-own lease. And there’s a major difference between them, don’t make this decision lightly.
There’s lease option agreements and lease-purchase agreements.
Although they sound like similar contracts, there is one crucial difference. When you enter a lease option agreement, it gives you the option to buy the home once your lease expires.
A lease-purchase agreement requires that you purchase the property at the end of your contract.
One gives you the option, the other forces you to buy the property. If you enter a lease-purchase agreement, you are legally required to buy the home. Only enter this agreement if you’re completely committed to going through with it.
The Benefits of Rent to Own
One of the biggest benefits of a rent to own agreement is to get breathing room with your credit score.
If your credit score is too low, you might not be able to get approved for a mortgage at all. Even if you can get a mortgage, you want a credit score that’s as high as possible. A higher score means you’ll save tens of thousands of dollars from having a lower interest rate on your mortgage..
If your score isn’t high enough, a rent-to-own agreement works in your favor. The lease gives you the time to raise your credit score before applying for a mortgage. Assuming you make all your debt payments on time, your score will be higher when your rent-to-own agreement ends than it is today.
Be careful though, taking on a mortgage is the single biggest purchase that most of us will make. If it was me, I’d wait longer, save up a down payment, and get my credit score pretty high before buying a house. I wouldn’t use rent-to-own to get a house at a lower credit score.
Another benefit of entering a rent-to-own agreement is locking down the price of your dream home. This can be extremely beneficial if it looks like the housing market is destined to increase the cost of your desired home.
The biggest benefit is that some of your rental payments go towards the down payment on a home. You’re building equity into the property before purchase. Be sure to check the math in your agreement. Your total rent will be higher than market rate and only a percentage of your total payment goes towards the down payment. If that portion is higher than the rent increase, you come out ahead. If not, you’d be better off renting and saving for a down payment like normal.
And, of course, you get to live in your home sooner. This is probably the biggest benefit. There’s a couple of situations that would benefit greatly from this:
- You need to get into the right school district but don’t have a down payment saved up yet.
- Unexpectedly, you need to move closer to family to help care for a relative.
- For whatever reason, you’re forced to move and have a lifestyle or requirements that don’t work in an apartment building.
If you’re forced to move and don’t already have a downpayment for a house, rent-to-own could be a good option. It gets you into a house now and allows you to buy it later.
I particularly like the lease option agreement. I’d be able to try the house for a few years and see if it’s truly a good fit before committing to a whole mortgage. Some problems can’t be detected until you’ve lived in the house:
- Crazy neighbors
- A horrible HOA
- Major repairs that weren’t picked up during the inspection
- If it truly fits with your lifestyle
After you’ve lived in a house for awhile, you’ll know if it’s a good long-term fit.
The Problems With Rent to Own
There are some serious downsides to entering a rent-to-own lease. Many landlords, when establishing a rent-to-own contract, require their tenants to handle the property’s maintenance and repair costs. These costs can be substantial.
You might even be responsible for any HOA fees or property taxes while you’re renting the home. The landlord could also make utilities like landscaping, trash collection, or water your responsibility as well. While it’s typical for landlords to cover all this, they don’t have to if the lease agreement assigns these costs to you. Landlords can also neglect to maintain the property if the contract doesn’t define their exact responsibilities.
Even if you have the option not to buy the house, landlords are incentivized to encourage you to move. They’d keep all the extra payments and still have the option to sell the property or rent it out again.
That’s why it’s crucial to go over a rent-to-own lease with a legal professional. You never know what a landlord will include, and you want to make sure you’re able to fill your contractual obligations.
Rent-to-own agreements often consist of something called option money. This money is a one-time required payment given to the seller as a nonrefundable fee.
Paying this “option money” grants you the opportunity to buy the property. In some cases, the seller puts this payment towards the home’s equity, but there is no guarantee.
While there is no set option money amount, it’s usually a percentage of the property’s price. Many landlords require three to ten percent of the property price upfront, and then you pay an above-market rent while you live there. Doing this allows landlords to collect market rent and use the extra money towards the final price of your home.
Let’s recap all the fees:
- Higher rent to account for a portion of it going towards a future down payment.
- The option fee that you pay when entering the lease.
- Possibly all maintenance, upkeep, and taxes depending on the agreement.
On top of all this, your landlord retains ownership of the property.
If anything terrible happens to your landlord, and they fail to pay the mortgage– you could lose your right to buy the house.
The potential problems don’t stop there.
Let’s say your landlord stops paying property taxes or even suffers from bankruptcy.
You could be left in the dust as your rent-to-own lease becomes null and void. You’re taking on significant risk that your higher rent payments, option fee, and maintenance costs amount to nothing.
That’s too much risk for me on the biggest purchase that I’ll ever make. I’d rather keep things super simple and wait until I can get a standard mortgage.
What happens if you decide not to buy the property, assuming you have the option in your contract?
Well, you likely forfeit all your previous payments. Rent-to-own isn’t like a normal savings account. You can’t take that down payment elsewhere. If you walk, the landlord keeps it. That could be a hefty cost for not buying the property.
Is Rent or Own Right for You?
If your credit isn’t high enough to get the mortgage that you want, I don’t recommend getting a rent-to-own lease. The fees are too high, there’s too much risk if something happens to the landlord, and there’s lots of ways for these agreements to work against you.
Too much risk and not enough benefit.
I’d only consider a rent-to-own agreement if I was forced to move, couldn’t get an apartment, and was willing to pay extra in the short term for the option to buy later.
Even then, Id try to rent a house normally first.
And I’d be paranoid about every term in the lease agreement if I did move forward with a rent-to-own lease.
That said, if the benefits outweigh the costs for you, rent-to-own is an option.