This is How You Get Started With Rent to Own
/If you’ve found the home you want to buy, but don’t have enough for the down payment or a high enough credit score to secure a competitive loan package, you should consider approaching the seller with a rent-to-own proposal. Find out how it works and why renting to own can benefit both you and the seller.
What’s involved in renting to own?
Renting to own is a formal agreement between a tenant and a landlord that allows the tenant to purchase the property being rented at a future time. The tenant pays an upfront option fee at a purchase price both parties agree to, and that gives the tenant the exclusive right to buy at a future point in time.
Included in the agreement is an amount above and beyond the monthly rent that the tenant pays toward the eventual down payment. If the tenant decides not to purchase the property, the option fee and any money paid toward the down payment are forfeited. The tenant cannot be held liable for refusing to go through with the agreement.
What you need to know
1. What the agreement structure is
You have to understand all the terms of the agreement. This includes what the option fee is (it can vary from a few hundred dollars to 20% of the purchase price). The option fee legally binds the landlord to sell to the tenant at the end of the rent-to-own agreement even if the landlord changes his mind. The option fee is nonrefundable.
It is customary to pay above market for the monthly rent with a portion of the rent going to your eventual down payment. For instance, say you’re paying $2000 rent a month for a $250,000 home, and $400 each month goes toward the down payment, and you have a 24-month lease. At the end of the 24 months, you have the option to turn that $9600 into a 3.8% down payment. If you decide you don’t want the house, you forfeit the down payment money.
Rent-to-own agreements are typically longer than traditional lease agreements. Three years is customary. Consider contacting a real estate attorney familiar with rent-to-own agreements who will look over the documents before you sign anything.
2. Who’s responsible for what
Your agreement should spell out who is responsible for maintenance and repairs, and who’s paying for the homeowner’s insurance, association fees, and utilities. You will probably have to pay the renter’s insurance, while the seller will be responsible for the landlord’s insurance.
The tenant is responsible for securing a mortgage for the purchase of the property. At the end of the rent-to-own agreement, the mortgage lender will transfer funds to the seller in return for title to the property.
3. What you need to do to prepare for a purchase
You need to talk to a lender to make sure they’re willing to credit the money you have paid to the seller, above your rent payment, to cover the down payment and closing costs. When you get into a rent-to-own situation with your landlord, you need to be confident you’ll qualify for a loan in the amount of the purchase price.
In addition to accumulating the money for your down payment, you should be working on improving your credit score so you’ll be eligible for the best possible interest rate. The easiest way to do that is to pay down your current debt, don’t obligate yourself to any additional debt, and pay all your bills as they come due.
4. What houses are selling for in your area
With a rent-to-own agreement, you either predetermine the purchase price or make it contingent on a home appraisal when you get ready to buy. Home prices fluctuate all the time. You need to decide on how much room you have to negotiate before you sign any agreement.
If you want to bet on prices going up before you decide to buy, you should lock in the purchase price at the beginning. If you lose the bet, and the market tanks, you could end up owing more than the house is worth. In this case, you may have trouble finding a lender to loan you enough money for the purchase.
5. Whether a home inspection is necessary
A home inspection will ensure you’re making a good investment. Home inspections aren’t free, but they are worth it if they uncover serious structural problems. The few hundred dollars you’ll pay will be a good investment in the long run. If there are significant problems, you need to come to an agreement with the seller as to who will pay for the repairs and when.
6. Why it’s a good deal for you
Down payment. Your down payment will be assured because you’ve been including it in your rent payment for the length of the rent-to-own agreement. You just have to take into consideration that your monthly rent payment will be higher than the market because it includes the additional amount for your down payment.
Savings. Everybody hates to move. It’s expensive and disruptive. One of the pluses of buying the home you’ve been renting is that there are no moving hassles. You save money, time, and headaches because you’ve already moved in.
FICO score. If your credit score isn’t what it should be in the beginning, you won’t lose out on the home of your dreams. Renting to own gives you a chance to improve your credit score so you qualify for the most attractive financing package when you finally get ready to buy.
Built up equity. If you lock in the purchase at the beginning of the rent-to-own agreement, and a strong market increases the value of the home, you’ll have equity in your new home before you start paying off the mortgage.
7. Why it’s a good deal for the seller
Big payment upfront. The seller gets the upfront option fee whether or not the deal ever goes through.
Attracts good tenants. It can be hard to find responsible tenants. When a landlord enters into a rent-to-own agreement, the tenant is much more likely to take good care of the property because he has a vested interest in it.
Built-in default benefit. If the tenant decides not to pursue the purchase of the property, the landlord retains all the down payment that has been made for the life of the agreement.
Established sale price. The seller can come out ahead of the game if he locks in a purchase price and bets the market will slow down before the rent-to-own agreement ends. On the other hand, if the market surges, the seller may walk away with less money in his pocket than expected.
Selling simplification. The seller can eliminate the cost of hiring a Realtor and paying a hefty commission by agreeing to a rent-to-own agreement. All he has to do is transfer ownership at the closing table.
You should treat a rent-to-own agreement in the same way you would a purchase agreement because it’s the same thing. It can be a great deal for the owner of a hard-to-sell house. It can also be the perfect solution for a buyer who loves the house but isn’t quite prepared to purchase it.
Either way, it’s important for both parties that an experienced real estate attorney look over the documents before anyone signs anything. It may be that the attorney will suggest two documents – a lease agreement and a separate purchase agreement.
Whether you are the buyer or the seller, it’s very important that you completely understand the terms of any agreement you sign and ask questions until you do.