How Does Rent to Own Work?
As the name implies, a rent-to-own agreement is where a person can rent a home for a certain amount of time with an option to buy before the lease expires. Rent to own will come with a standard lease agreement and often the ability to pay a percentage of your purchase price through rent payments. This percentage can be negotiated between you and your landlord and will be used as a down payment towards your home purchase. Rent to own is a great option for people struggling to repair their credit and who may need a few years before they are eligible for a loan.
How to Acquire a Rent to Own Agreement
When searching for properties, rent-to-own lease agreements are not always the most available options on the market. Rentals and sales will almost always be the main property listings throughout your search, but there are specific circumstances under which you can find your rent to own. The following are places you should begin looking for the best availabilities.
Look for properties that have been on the market for quite some time and might be having trouble with finalizing a sale. If a property you have been looking at has been on the market for six months or longer, you may wish to approach the seller and ask if they would be willing to sign a rent-to-own lease agreement.
If you are currently in a rental and the landlord wishes to sell, it may be a good opportunity to ask whether or not a rent-to-own could be mutually beneficial. Even if the conversation of a sale has not been brought to the table, but you have been in your home for an extended period, it may be a good idea to ask your landlord if they are open to discussing a rent-to-own agreement.
Types of Rent to Own Agreements and Key Terms
You will encounter two standard forms of legal lease agreements when asking about a rent to own. Familiarize yourself with the following terms while navigating your options for a rent to own:
Lease Option
An option to purchase lease agreement wherein the purchaser commits to an option payment to the seller for the exclusive rights to the conveyance of the property within a specified time frame. Terms should be discussed whether the purchase price will be set from the signing of the lease agreement, or if the buyer will agree to pay market value at the time the contract is exercised. Depending on fluctuating market values, it may be in your best interest to look at market projections for your area and the coming years to see whether or not a set purchase price at signing would be better than the market value price at closing.
This option typically takes place between one and three years. Option payments are rarely refundable, but you will not be locked in to the purchase and may be able to sell your option to another buyer if the seller agrees to the terms. If you do not exercise your option to purchase, it will expire. You also have the option to put a portion of the monthly rent payments towards your purchase price, often at an inflated rate. Remember that a rent-to-own agreement will typically be accompanied by a contract stating your responsibility to maintain the property throughout the rental agreement during this period.
Lease Purchase
A lease purchase agreement is an arrangement wherein you are legally obligated to pay the seller in full at the end of your lease. While this option typically ranges from 1 to 3 years, a portion of the monthly lease payment will go towards the purchase price. If you are considering taking a lease agreement with purchase, make sure to have a full home inspection and pre-approval for a mortgage to make sure you will qualify and that there will be no additional expenses regarding renovations and insurance after closing that could harm you financially.
Option Payment
And option payment is a one time lump sum fee you will pay to retain the option of renting to own within a designated time frame. Option fees are negotiable and typically range between 2% and 7%. Occasionally the fee may be applied to the purchase price, but it is very rarely refundable if you decide against your purchase.
Rent Credit
While retaining a rent-to-own option, it is typical that a portion of your rent will go towards a down payment on your future home. Rent credits can range between 10% and 25%, but negotiating this with your landlord is key. It is also standard practice to request that all rent credits be kept in an escrow account until purchase to protect both yourself and the seller.
During a lease option or lease purchase agreement, your rent price will be higher than the market rate as you’ll be accruing funds to use towards your down payment at closing. Getting pre-approved for a mortgage before signing a rent-to-own agreement will help ensure you can afford the home at the end of your contracted period. Before signing a rent-to-own agreement, discuss the purchase price with the seller so you are prepared to approach the pre-approval process. Once rent payments inflate to account for your down payment, having already received a pre-approval determining the home’s affordability will work in your favor for certain types of loans, such as FHA.
If you choose to go with either a lease option or lease purchase, make sure to retain a professional real estate lawyer to draft all legal documents, check for liens, encumbrances, state regulations, tax considerations, and explain your rights regarding the possession and possible default consequences. Before committing to a lease option or lease purchase agreement, make sure to examine a title policy, get a proper appraisal, and hire a home inspector to make sure there are no underlying issues with your real estate purchase.