Rent to Own – How Does It Work?

Rent to own properties make it easier for low-income residents to acquire homes. This concept entails allowing you to live in a property by signing a rental agreement, but you’ll also have the option to buy the property later.

The concept of a rent to own property is alluring, as it doesn’t require you to spend as much money on a property. Instead of buying that building altogether, you’re renting it. You’ll also use some of that rent money to cover a down payment.

But there will be various terms associated with a rent to own agreement. The timeframe of an agreement will vary, and you might be required to purchase the property altogether after a while. There’s also the risk of getting into a property that might not be in good shape. Understanding what you’re getting into when entering a rent to own agreement is critical to your success.

The General Concept

The rent to own process involves spending small amounts of money on a property now and eventually purchasing it after a while if you’re interested.

In a rent to own agreement, you will sign a rental deal or lease where you can live in the property. You’ll then receive the option or requirement to buy the property later. The timeframe for when that option or requirement will appear will vary, but it can take about two to four years on average.

The monthly rent payments you make will go toward a down payment on the property if you choose to purchase it later. You can review your rental agreement to see how much of your payments are going toward that future down payment.

The idea here is to help low-income residents get into properties. As that person earns more money and builds one’s credit history, it becomes easier for that person to get a home loan later, thus allowing that someone to afford to purchase the property with a home loan.

Do You Need a Good Credit History?

One of the best parts of rent to own homes is that you don’t need much credit history for this process.

Most purchases on new properties require you to have a good credit rating. But with a rent to own process, you’re building up credit through the monthly payments you complete. By completing your payments as necessary, you’re improving your credit score and becoming more likely to get favorable terms for a loan if you buy the property.

How Does This Process Work?

You can enter into a rent to own agreement with a property owner, but you’ll need to review how the practice works first. Here are some steps for how you can make this work:

  1. Check the market for properties with rent to own options.

Most major real estate listing websites will have sections where you can see what rent to own properties are available. You’ll find everything from standalone single-family houses to townhomes to apartment units.

  1. You can consult with the property owner about a rent to own agreement.

Be sure when talking with the property owner that you provide enough info on your situation. You can list details on your income sources, your current savings, and any plans you have for the property.

Since you’re not the complete property owner yet, you will likely have limits on what you can do with the building. Your agreement will include rules on what you can do with your space.

  1. You’ll agree to either a lease-option or lease-purchase deal.

The deal will let you either have the option to buy the home or require you to buy it after a while.

The timeframe for the deal will vary. It will last for about two to three years in most situations.

  1. Some fees may apply at the start.

In addition to processing fees, you might have to pay an option fee. This fee is worth a percentage of the total price of the property and will give you the option to buy the home later. You’re more likely to come across these fees when you’re in a lease-option agreement.

  1. After the timeframe expires, you’ll have the option or requirement to buy the property.

In this situation, you’ll use part of whatever you spent on rent payments as part of the down payment on the property. This measure could help reduce the total you’d have to borrow from a home loan later. But the total amount that goes toward that down payment will depend on what your agreement says.

  1. In cases where you have the option, you can extend the rent agreement.

The timeframe also varies, but you could extend that agreement by two to four more years.

Lease-Option vs. Lease-Purchase

Depending on the situation, you will get into one of two different rent to buy agreements:

Lease-Option

A lease-option deal means you aren’t obligated to buy the home after the term ends. You will continue to hold that option and get the choice to extend the deal if you prefer.

You’ll still be subject to conditions that could cause you to lose that option if you’re not careful. You could lose the option if you don’t make payments on time or discuss your plans for the property within a deadline.

Lease-Purchase

You’ll be required to purchase the property after the lease term ends in this option. You could experience some punishment if you don’t choose to buy the property. You might not only lose the property if you don’t pay but also lose the credit you had for the down payment. Therefore, any cases where you’d want to buy the property later would be done without the down payment going toward anything.

A Quick Example

Now that you understand how a rent to own process works, let’s look at a simple example of how this can work:

  1. As you set the contract with the owner, you can determine various terms.

Some of the terms you’ll establish will include:

In this example, let’s suppose the purchase price for your property is $300,000. You could establish an option fee worth 1 percent of the home’s value. In this case, the option fee will be $3,000. You’ll spend that money to go toward the option of buying the property later.

You’ll then plan a timeframe for how long the agreement will last. Let’s go with a three-year term for this example.

As for how much you’ll spend on monthly rent payments, you could set up a deal where you’ll spend a percentage of the home’s value on monthly payments.

In this example, we’ll suppose you’re spending 0.5 percent of the home’s value each month. Therefore, you’d pay $1,500 monthly for the property with a $300,000 purchase price.

Finally, there’s the deal for how much of your payments will go toward the down payment. In this situation, let’s suppose you put in $300 per month toward that payment.

  1. A portion of the rent payments you make will go toward the down payment.

Assuming you make those $1,500 monthly payments over the three years of your deal, you’ll spend $54,000 on the home during that timeframe. But the total amount that goes toward the future down payment will be less.

Since $300 per payment will go toward the down payment, you’re putting in a $10,800 down payment. That’s worth 3.6 percent of the $300,000 purchase price.

Depending on the situation, the option fee might be included in that down payment. In this example, that down payment would rise to $13,800, or 4.6 percent of that price.

  1. When the time comes to purchase the home, you can get the home with a suitable loan, assuming you’re pre-approved for it.

Since you’re building your credit history through your monthly payments, you’ll have an easier time getting a home loan. You can use the down payment you saved to reduce the loan principal, plus you’ll have a better rate because your credit is better.

You’ll require pre-approval for a home loan before the option arrives. The pre-approval process means you’ll qualify for a loan at a particular rate. By providing info on this loan, you can use the option to go forward with a purchase.

Concerns About Rent To Own Properties

While rent to own options are great for low-income residents looking for homes, there are some risks to consider. Remember that while this is beneficial, it is not with concern:

  1. The option fee you’ll spend at the start will be non-refundable.

The option fee isn’t refundable, so you’ll lose those funds if you choose not to buy the home at the end of the term.

  1. The option fee might not go toward the down payment.

Depending on the contract, the option fee might not be part of the funds you use in your purchase, so be careful when making it work. Comparing the option fee to the total down payment is necessary for success.

  1. The purchase price may be stable, which is concerning in down markets.

Your agreement will likely set the purchase price in stone. This measure means you’ll be protected if the property value goes up in the years after you enter the rent to own deal. But if the price drops, you’ll still pay more than the house is worth. Considering how you’d lose your down payment if you don’t exercise the option to buy, you’d end up wasting more on your home than you want.

  1. Sometimes rent to own properties might be in poor condition or are in foreclosure.

If the property is in poor condition, you’d have to pay for various repairs, including fixing damage, removing asbestos or lead, and other risks.

For cases where the house is in foreclosure, you’d have to pay for whatever unpaid taxes and other expenses come with the property. This measure means the property owner could pass years of unpaid taxes off to you.

What To Do When Entering a Rent To Own Deal

With all these points in mind, you might be curious about entering a rent to own agreement. Here are some measures to follow when entering a plan:

A Final Word

A rent to own property will help you get into a home you want without buying it immediately. It’ll be easier for you to afford that home when the time comes to buy it, as you’re building your credit and saving money for a down payment. You’ll still need to watch for the terms of your agreement, including how well the process will work and if there’s a risk attached to it.

 

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