Rent-to-own agreements can be an outstanding way to help you if you are currently renting and want to buy a house. Rent-to-own homes, also known as lease purchase, may appeal to borrowers with the income but not the credit to buy the home they desire.
This hybrid lease/purchase agreement gives you the opportunity to lock down the property’s price today and rent the house out as a “test drive”. Even if your credit score isn’t high enough or you don’t have the funds to make a down payment, rent-to-own agreements may be a way to become a homeowner.
What is a Rent to Own Home?
Lease-to-own and rent-to-own contracts allow homebuyers to sell real estate for a longer period of time. They are similar to hybrid lease agreements, with the option to buy the property at the end of the lease.
There are two types of rent to own agreements: lease option and lease purchase. Before entering into any rent to own transaction, it is important to know the differences between these two types of agreements.
Lease-Option Contracts allow you to purchase the property after the end of the initial lease period, but you are not legally bound to do so.
These agreements are more favorable for buyers. These agreements are best if you are unsure about your decision to buy the property. They allow you to modify your mind after your lease ends.
Lease-Purchase Agreements require that you purchase the property at lease’s end. This can be difficult if financing is not available, which could lead to lawsuits.
These agreements are more advantageous to the seller. Therefore, you need to be sure that you will be able to buy the home after the lease ends.
What is Rent-to-Own?
Rent-to-own agreements typically last one to three years. They typically include three components: the option fee and the purchase price.
Lease Option Fee This upfront deposit secures your ability later on to purchase the property. The fee ranges from 2.0% to 7.5% of a home’s agreed-upon purchase cost, but it is usually negotiable.
If you choose not to buy the property under a lease option contract you will lose the fee. However, it can be applied towards the down payment if the buyer does decide to proceed with the purchase.
Purchase price: Before entering into a contract, it is necessary to agree on the purchase price for the home. The seller and you can agree on the price upfront so there’s no back-and forth when it comes time to close the deal.
To compensate the owner for taking their home off the market, this will typically be at or slightly higher than the current market value of the property.
Rent Premium This is the amount of each month’s rent that goes towards your down payment. These funds are held by the seller in an escrow until you exercise your right to purchase the property.
This premium is non-refundable if the property is not purchased. It is important to understand how much rent you are contributing to this premium. The rent premium means that your rental payments will be higher than the market price during the lease period.
Let’s propose that you are looking to rent-to own a house for $250,000. This will illustrate the cost of a rent–to-own agreement. You will need to pay $5,000 upfront if the lease option is 2%.
The rent premium will be $200. You’ll then have to pay $1700 per month.
You’ll receive $17,000 in escrow at the end of your five-year lease. This includes $5K from the initial option fee, $12,000 from five years of rent premiums, and $5,000 from the final option fee. This money can be used to pay the down payment or forfeited if the home is not purchased. Lease-option contracts only.
What happens after the lease expires?
If you intend to sell the property after the lease term expires, you will need a mortgage. It is a good idea to apply for a mortgage at the least one month before your lease expires. You will hopefully have built up your credit score by this time to be eligible for competitive financing.
Seller carry financing is another option if you are unable to get a bank loan. The seller will “carry the loan” while you make the principal and interest payments. This is similar to buying a home, but the seller acts as a lender. This can be agreed upon at the initiation of the lease or at the end.
Assuming the seller holds an assumable mortgage, you can also assume their loan. This means that you will take over their payments and be added to the title or deed. This type of transfer is rare as most mortgages cannot be assumed. However, you will need to qualify separately for the assumed loan depending on your ability to repay.
Conventional mortgages cannot be assumed. However, certain mortgages that are FHA or VA approved may allow loan assumption. It is up to the seller to check with their lender whether such a practice is permitted for their home loan. The seller may also have equity in the property that you will need to purchase. This can be a large down payment.
Are You Considering a Rent to Own Home?
Rent-to-own agreements are a good option for qualified borrowers who want to save money on a downpayment but still lock in their purchase price today. It can be challenging to obtain a non-conforming mortgage (or jumbo) in high-cost, rapidly increasing real estate markets. Potential homebuyers can rent-to-own agreements as a way to build their savings and secure a purchase price.
Rent-to-own properties are also an option for first-time homebuyers. The strict underwriting guidelines may be a barrier to entry. Recent entrants to work may struggle to qualify for a mortgage loan. Most lenders require at minimum two years of income verification and tax filings. This is regardless of your income. Rent-to-own agreements lock you in on the purchase price and give you more time to build credit.
If borrowers are eligible for a mortgage and have the funds to pay a down payment, they may choose to buy a property instead of renting it.
You can purchase the property in one step, without having to deal with a rent-to own or lease-to own agreement. This allows you to avoid paying high rent that could otherwise go towards a mortgage.
Important Points to Consider
Rent-to-own agreements lock in a purchase price now and a multi-year lease commitment. This basically ties you down to the present. This agreement is not recommended as it carries a lot of risk. Before signing a rent to own contract, it is important to be aware of the following points.
Get legal help: Our Beverly Hills Mortgage Brokers suggest that you talk to a qualified real-estate attorney to ensure you fully understand your contract and all of the obligations. They can assist you with contract negotiations as well as confirming that the property is in good condition without tax or title issues.
Understand the Agreement: Make sure to read every word of the contract and understand the key points, including due dates, option fees, rental payments, credits and how to exercise your buy option.
It is important to be aware of the responsibilities of each side, such as who is responsible for maintenance or repairs during the lease term, and who is responsible to pay HOA dues.
Follow the Traditional Process of Purchasing: Get an independent appraisal, complete a home inspection, and do a title search. Do not assume that the property is free from problems just because it was vacant during your lease term.
Do your due diligence when it comes to the seller: Be aware of red flags such as collections, tax lien or judgments. Avoid properties that are at risk of being foreclosed or in bankruptcy proceedings.
Protect your Investment: Take note of the amount you are paying upfront and how much is being paid to your rent credit (and down payment).
These funds should not be commingled or merged with other accounts of the seller. You should avoid penalties for missing or late payments as they could affect your ability to buy the house later.
How to find Rent-to-Own Properties Near You
You are best to look for a homeowner who has put their property on the market for a while (typically more than 3 months) and decided to rent it out instead.
Although most homeowners are reluctant to consider a rent to own agreement, you can influence their minds by offering to pay for repair and tax costs. Many terms of these agreements are open to negotiation due to their unusual nature.
Rent-to-own houses are generally more popular in smaller towns and cities, where there is not much activity in the real estate market.
Although you won’t find many listings for rent-to-own in your area, foreclosure.com might list some options. If you live in larger cities, it may be possible to find specific rent-to-own websites that are focused on your area.