The alternative option to buying a home outright is rent-to-own. This agreement is also known as a lease-to-own option. When buyers enter into this form of agreement, they are agreeing to rent a home for a specific amount of time at the end of which they can opt to buy the property up until the lease expires.
Though it's not the most common way to buy a home, it's an option for those with lower income or bad credit to purchase a property. The selection of properties that are rent-to-own is much smaller than the selection of homes that are simply for sale, but these options are out there to be had.
How Does It Work?
When you enter into a rent-to-own agreement, you, the potential buyer, get to move in right away. Keep in mind that no two contracts are the same when it comes to rent-to-own. You will, typically, rent the property for a set amount of time with the option to buy after the time period comes to a close. There are, of course, certain conditions and terms that you might be required to meet in accordance with the contract that you sign.
Breaking It Down: What You Need To Know
In your agreement to rent-to-own, the buyer will pay the seller a one time lease option fee. This fee is usually nonrefundable. The fee is usually called "option consideration" or "option money". Like stock options, this will give the renter the opportunity to buy the house when the time comes. Please note that in some contracts this gives the renter the right to purchase the property, but they are under no obligation to do so. If the renter chooses not to buy the property at the end of the term then the option will simply expire. If this appeals to you, then make sure that your "lease-purchase" agreement also has the word "option" attached to it. As with all contracts, it comes to down to clarifying the wording. If you leave out the word, "option" then you could face problems if you try backing out of the contract. Option sizes are negotiable and there isn't usually a standard rate. In most contracts, some or all of the option money is applied to the purchase price when you close.
The contract should specify how and when the purchase price of the house will be determined. In many cases, the seller and the buyer will agree on the price when the contract is signed. The buyer will usually choose to lock in the purchase price due to market increases being a possibility in the future.
During your lease term, the buyer will pay the seller a predetermined amount of rent per month. In most contracts, a percentage of the rent each month is applied toward the purchase price. This is called rent credit. In some cases, the entire month's rent goes into the purchase of the home.
This really depends on the terms of your contract. You, the buyer, may be responsible for the maintenance of the property which includes paying for repairs. You may also be responsible for property taxes, homeowners association fees, and insurance. However, as it's still the seller's house, they may choose to cover the homeowner fees, the taxes, and the insurance. The buyer, in this case, will still want to have renters insurance. This will ensure that you're covered if your personal property is stolen or damaged. It will also cover the buyer if anyone is injured on the property as well as if the buyer accidentally injures someone within the house or on the property.
It's always wise to make sure what the maintenance and other requirements are within the contract. Raking the leaves and keeping the grass cut is much different than having to replace a damaged roof.
When the time comes to purchase the property from the seller, the buyer will usually apply for financing to pay the remaining balance in full. Remember that a portion of your rent, or all of it, will be applied to your balance. Once your option money has been calculated you will then owe the remaining amount of the properties worth. The balance will be due at the time of closing on the house.
Like all contracts, the contract for your rent-to-own home should state the name of the landlord (seller) and the name of the tenant (buyer). It should be dated and signed by both individuals. As well, like normal rental agreements, you should also state the names of all of the people that will be living withing the rent-to-own home that you will be moving into. The contract that you have should also have a legal description of the property and the full address as well as the parcel number. Including the parcel number will eliminate the potential for confusion regarding the address. To acquire the parcel number you can contact the local property tax assessor's office. You can also try their website.
Within the contract, the lease portion should include all of the things that you would find in a normal rental agreement. Here are some of the things that you need to look for:
- The beginning and end dates of your lease period and whether or not you can extend that period if need be.
- Under what conditions could your lease be extended.
- Rent amount, rent due date, where the payment should be sent, and what forms of payment are taken.
- Fees for returned checks or late rent.
- Security deposit amount (which should be refunded if there has been no damage to the property)
- Pets or no pets
- Smoking or non-smoking
- parking spaces if this applies
- Subletting rules and terms
- Which utilities you are responsible for.
- Eviction conditions
Some key differences between a normal lease and a rent-to-own lease are that under a normal lease agreement the landlord is required to pay for the repairs and handle the maintenance of the rental. On many occasions it is the renter, in a rent-to-own agreement, that is responsible for the repairs to the rental. The idea behind this is that the buyer of the rent-to-own has a long-term investment in the property. However, until you actually own the property, be wary of those sellers that won't agree to handle the major repairs to the property. You can also discuss adding on the cost of any repairs to your rent credit if the seller doesn't want to take the responsibility. All of these details should be hashed out and placed into the contract.
This is a little more complicated in that this portion of the contract has the ability to make a rent-to-own property a more favorable experience or it can allow the seller to obtain extra money from the buyer without the real intent to sell. Wording is everything within a contract. Your provisions should be worded properly and with thought to detail. Some of the things that you should see are:
- What the rent is and what portion of the rent is applied to your rent credit
- Your option deposit. Some agreements have you paying either an option deposit or a rent credit but not both.
- It should state that you have the right, exclusively, to buy the home at the end of the leasing period. This stipulation makes sure that the seller cannot let anyone else buy the house during the option period. Make sure that your option period is long enough to allow you to correct the reason behind your inability to qualify for a loan to buy a home in the first place. 2 to 3 years is the usual time frame before you must purchase the home in full. The contract should also state how much notice that you need to give the seller about your intent to buy.
- The contract should state the exact date that your option to buy expires.
- Structure your contract to allow you to buy the home sooner if you're able to do so at any time before your lease is up.
- It should state that the homeowner, until the house is purchased in full by the buyer, should maintain homeowners insurance, keep up with property taxes, and not be able to take out any new loans against the property or house.
Within the contract, the purchase of your rent-to-own agreement should be similar to that of a regular real estate agreement. Laws can vary from state to state and you may be required to have a standard contract for this. However, even with a standard contract agreement, there's plenty of room for negotiations to be filled in.
This area should state the purchase price which should be within current market values of similar homes. The seller will usually price the home at 5% to 10% higher to compensate for appreciation within the time of the rental period. It's good to keep in mind, though, that the value of the house could decrease as well. Having an alternative in case the value of the house decreases is always wise. Many places will not give you the loan that you require to buy the house in the end if the sum of the remaining balance is much higher than the value of the true value of the home.
Within the contract, it should also be stated very clearly what thing come with the house when you buy it. For instance, does the washer and dryer come with the house? Do you get to keep the refrigerator, any patio furniture, or the dishwasher? It's not safe to assume that you get to keep these things simply because they're within the house when you rent it. Everything must be spelled out and in writing.
As with all major contracts, it's always best to err on the side of caution and look at your rent-to-own contract in the same light you would if you were simply buying the home in the "normal" fashion. We cannot stress enough that diligence is a key factor in every transaction and can mean all the difference in the world.
Renting to own is not a new concept. Since the 1950's this form of home ownership has been in play. Leasing agreements have become more prevalent since that time as it's become very difficult to obtain a home loan these days. Because of the difficulty in obtaining home loans; rent-to-own homes are being seen on the market more and more. Sellers know that rent-to-own isn't a great sum all at once, but in order to sell a home, this method has become an even better way to do so.