But there is something called a rent-to-own program that can help first-time homeowners get into a property and begin saving toward a final purchase without meeting the financial requirements of a traditional mortgage right away. Here is a look at rent-to-own programs and how to find one that works for your situation.
A rent-to-own program allows residents to purchase a home by first becoming a tenant. This allows the prospective homeowner to live in the property while saving toward a down payment or working on their credit. Then after a certain period, the tenant has the option or right to purchase the home. In some programs, part of their monthly rent payment will also go toward the purchase.
Rent-to-own contracts vary depending on the state and the program offering them. But typically, the owner and the tenant will agree on a price (or set a date for an appraisal) and an amount of time before the home can be purchased. This essentially allows the tenant to make a down payment over time, rather than all at once.
The owner will often charge an upfront fee (called an option fee) and agree to put a certain portion of the rent payments into an escrow account to be put toward the ultimate purchase of the home. This usually means your monthly payments will be higher than the market rate.
So, let’s say the home is worth $200,000 and the rent is $2000. The owner will also require a 5% option fee ($10,000) but agrees to put 20% of the monthly rent payment into escrow.
So, after 4 years, you would have the $10,000 you put down, plus an additional $19,200 in escrow. This would go toward the final purchase price of the home, instead of a traditional down payment.
The exact conditions of the contract will vary from program to program. Some rent-to-own companies will not require an up-front fee and others may not guarantee a certain percentage to be put in escrow. But this is generally how most rent-to-own programs work.
There are a variety of different rent-to-own programs available with different terms and conditions. But the two main categories are lease option and lease purchase.
1. Lease Option
A lease option gives you the option to purchase the home at the end of the contract. Typically, this will require you to pay an option fee at the beginning of the term to show that they are serious. This option fee will typically go toward the final purchase price at the end of the contract.
Once the lease expires, you can negotiate a final purchase price if you decide to buy the home. If circumstances have changed since you first signed the contract, you may decide to simply walk away. But, depending on the contract you sign, you might also lose your option fee and any money from your rent payments put into escrow. This can be a good idea for those who are uncertain whether or not they want to buy the home. But it also carries its risks, so be aware of the potential downside.
A lease purchase is another common type of rent-to-own program. Unlike with a lease option, you are agreeing to purchase the home at the end of the lease for an agreed-upon price. This price could be set at the time that the contract is signed, or it could require an appraisal at the end of the term to accommodate a change in housing prices.
This is a good option for those who have found their dream home but aren’t quite ready to apply for a mortgage loan. It’s a good way to get into the property and start accumulating rent credits if you know you've found the right place. But if you decide not to purchase the home at the end of the lease, you could face legal consequences for breaking the contract. Be sure to read the lease-purchase agreement thoroughly so you understand exactly how it works.
Rent-to-own programs can be useful for those who are looking to get into a home as soon as possible and want to build savings and work on their financial profile. But applicants should be careful because these programs carry a variety of risks.
If you don’t end up purchasing the home or don’t qualify for a mortgage after the lease expires, you may lose all the money you put toward the purchase, putting you in a worse position than when you started. So, before you sign a contract, make sure you find a reputable program and a home you can see yourself living in for the foreseeable future. Here are some of the best rent-to-own home companies in the United States.
Dream America is a rent-to-own program designed for those who have the funds needed to qualify for a mortgage, but not the credit score. They accept applicants with as low as a 500-credit score and a budget of $150,000 or higher. They will purchase the home and rent it to the applicant for 12 months while helping them improve their credit and putting 10% of the monthly rent payments toward the final purchase. Once the applicant can qualify for a mortgage, they can cancel the lease with no penalty, then buy the property for themselves.
Divvy is a program that helps people in major urban areas purchase homes. Prospective home buyers will apply through Divvy and be approved for a certain amount based on their underwriting criteria. They will then be paired with an agent who will help them find the right property. Divvy will purchase the property and lease it to the applicant, who will be required to put down 1% or 2% of the purchase price. After a set period, a portion of the applicant’s rent payments will be put in escrow. But, if the applicant ultimately decides not to purchase the home, they can get their money back, minus a relisting fee.
Home Partners is another popular rent-to-own program. Interested parties apply directly through Home Partner’s website and will be approved for a certain budget based on their financial qualifications. Home Partners has certain preapproved communities that they work with. Applicants can choose a property from their website or work alongside an approved realtor to find a property that meets the program standards.
Once the applicant has found a home that meets the requirements, Home Partners will purchase it and rent it to the applicant through a lease option contract. Tenants have the option to purchase the home at any time during the lease. Or if they choose not to buy the home at the end of the contract, they may leave without any penalty.
These are large, reputable companies that operate in certain areas all across the country. But there are certainly other options available for homeowners looking for a rent-to-own program. A good way to find a local program that meets your needs is to do a quick google search or consult with a licensed real estate agent you trust. There are plenty of great local programs out there. But you have to be careful to avoid getting scammed or paying hefty penalties if you ultimately decide not to purchase.