What is rent to own?
Rent to own is a contract where you rent a house for a specific period of time with the option to buy it before the contract expires. It consists of two contracts.
- Standard lease contract
- Option contract to buy the house
Most people think that they can either buy a house or rent a house. Buying a house requires a huge mortgage to finance the home, so you need a good credit score. Therefore, with rent to own agreement, you have the option to buy the house while you are living in it as a tenant. Meanwhile, you can pay off your previous debts to improve your credit score.
Standard Lease Option Contract:
The lease option contract gives the buyer the right to buy the house before the contract expires whereas, the buy lease contract requires the buyer to buy it.
In a rent to own contract, the buyer (the tenant) needs to pay a small down payment as the monthly premium. All the amounts are mentioned in the agreement, therefore, it does not change until the agreement expires.
Rent to own contract exapmle
Let’s understand the rent to own with an example. Suppose you are interested in owning a house. Let’s say the price of the house is $150000 and the rent is $1000. But with rent to own agreement, you will have to pay some extra amount, so let’s assume it to be $250. What is this extra amount, we will discuss in the next section of the article. Therefore, your total rent will be $1250 for a period of 2 years.
After two years, you would have paid a total of $30000. Now the mortgage amount is $150000 – $30000 i.e. equal to $120000.
Rent to own vs Mortgage
Rent to own is a good option for people who want to buy a house, but either does not have enough savings or are not prepared for a mortgage. It is the best alternative for people who want to improve their credit scores. It gives the buyer the time to pay their bills and improve their credit score.
With the rent to buy option, the buyer has to pay some extra money. This extra money goes into purchasing the house. This helps the buyer to pay the down payment while living in the house.
Things to consider before making a rent to own contract
Price is negotiable
In a rent to own agreement, you can negotiate the price and duration with the seller. The price of the house can be its current price or a predicted price. It also allows you to decide the time of the purchase of the house. Always remember, there is no standard contract, therefore, everything is negotiable.
Down payment and Set aside money
When buying a house, the buyer has to pay a 3% to 8% money as a down payment. This payment is the security or option money that the buyer gives for the option to buy the house in future.
But in rent to own option, the buyer has to pay the rent and additional money. This additional rent includes the rent and the credit for purchasing the home in future.
Repairs and Maintanence of the house
Before making the rent to own agreement, discuss the repair and maintenance costs. In most cases, the seller will ask the buyer to cover the maintenance and repair cost including the property tax.
The repair includes almost everything such as land scraping, broken pipelines, air conditioner units, etc. However, some parts are covered by the seller. Therefore, it is very crucial to understand each party’s responsibility before making the agreement.
Down payment to secure the option for buying the house
In some cases, the seller might ask for a down payment. The down payment usually ranges from 3% to 8% of the total price of the home. By paying the down payment, the buyer gets the option to buy the house in future. However, in some cases, the seller will agree to adjust this amount in monthly home equity.
Purchase before the lease term expire
The rent to own agreement has an expiry term. The buyer has to decide to purchase or not to purchase the home before this agreement expire.
From rent to buying transition of the home
If the buyer is sure about buying the house while living as a tenant, then the buyer needs financing before the lease expires. The mortgage lender will confirm the closing date and then the owner will transfer the ownership. Then the seller will credit the set-aside or option money to the seller.
Pros and cons
Pros for buyer
- More time for the down payment: Buyers have the time to pay the down payment of the home. Most sellers ask for the higher rent as it includes the down payment. Therefore, the buyer does not have the headache of paying the down payment right away. However, some sellers ask the buyer to pay down payment for the house.
- Don’t need mortgage immediately: Rent to own allows the buyer to move in the house even if the buyer does not qualify for the mortgage. It gives the buyer time to pay off the previous debts and improve the credit score.
Moving into the new home without qualifying for a mortgage might seem a good option initially. But, if the buyer is already in debt, this can be a financial mess for the buyer.
Cons for the buyer
- Higher rent: As a part of the rent goes into the equity of the house, therefore, monthly rent is higher than the normal rent.
The additional (set aside) money can be paid to the previous bank loans instead of paying to the landlord. - Pay for the repairs and upfront fees: The buyer might have to pay an upfront fee or down payment for the house. Also, do remember, that the buyer is responsible for most of the repair cost of the house. It can be another serious dent in the finances.
- Pay more than the worth of home: If the rent to own agreement is for a couple of years, the prices of the property might go up as well as down in future. Therefore, there is a risk of investing in a property that’s value might fall in future.
- Loss of money: The buyer will lose money in case he denies buying the home. If the buyer has to relocate due to a new job or does not qualify for the mortgage. Also, after spending some time, the buyer might feel that this is not the perfect house for him. In such cases, the buyer will lose the money that was paid as a downpayment or set aside money.
- Agreement favours the seller: In case of late payments or not paying for the maintenance on time, the seller can release from any commitment to honour the agreement.
- Seller doesn’t sell the house: If the landlord’s financial condition changes, then the house goes foreclosurer and not to the buyer. Also, if the seller doesn’t want to sell the house it will cost extra money to the buyer to pay for the legal actions that the buyer wishes or doesn’t wish to pay for.
Pros for seller
- Non-refundable down payment: Sellers get the down payment from tenants that are non-refundable. So there is a lower risk of tenants walking away. And even if the tenant walks away, sellers enjoy the extra money paid by the tenant.
- Caretaker of the property: The tenant will take care of the property and have to pay for the repairs required in the house.
- Higher sales prices even when the prices are low: In case the property rates are low, then also the seller gets a higher rent because of the previous agreement. Also, the risk of the tenant leaving the house is much less because then the buyer has to pay the down payment again for the new home.
Cons for seller
- Higher rate of the property in the market: In a rent to buy option, the biggest loss for the seller is when the property rates are much higher, and the seller is bound to sell at a lower price. In such a case, the seller has the obligation to sell the property at the predetermined price and not the market price. The contract gives the buyer the right to buy the property.
- Buyer will leave: Although the seller gets a strong down payment, there is a risk that the tenant may walk away before the contract expires. In this case, the seller has to either rent or sell the property again.
Also check: Different types of mutual funds to invest in
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