Rent-to-Own Homes: How it Works
If you’re like most homebuyers, you’ll need a mortgage to finance the purchase of a new house. To qualify, you must have a good credit score and cash for a down payment. Without these, the traditional route to homeownership may not be an option.
There is an alternative, however: a rent-to-own agreement, in which you rent a home for a certain amount of time, with the option to buy it before the lease expires. Rent-to-own agreements consist of two parts: a standard lease agreement and an option to buy.
In a Nutshell
A rent-to-own agreement is a deal in which you commit to renting a property for a specific period of time, with the option of buying it before the lease runs out.
Rent-to-own agreements include a standard lease agreement and also an option to buy the property at a later time.
Lease-option contracts give you the right to buy the home when the lease expires, while lease-purchase contracts require you to buy it.
You pay rent throughout the lease, and in some cases, a percentage of the payment is applied to the purchase price.
With some rent-to-own contracts, you may have to maintain the property and pay for repairs.
Nonrefundable Upfront Fees
In a rent-to-own agreement, you (as the buyer) pay the seller a one-time, usually nonrefundable, upfront fee called the option fee, option money, or option consideration. This fee is what gives you the option to buy the house by a future date.
Lease-Option vs. Lease-Purchase
Lease-option contracts give you the right, but not the obligation, to buy the home when the lease expires. If you decide not to buy the property at the end of the lease, the option simply expires, and you can walk away without any obligation to continue paying rent or to buy.
To have the option to buy without the obligation to buy, it needs to be a lease-option contract, not a lease-purchase. Because legalese can be challenging to decipher, it’s always a good idea to review the contract with a qualified real estate attorney before signing anything, so you know your rights and exactly what you’re getting into.
Agreeing on the Purchase Price
Rent-to-own agreements should specify when and how the home’s purchase price is determined. In some cases, you and the seller will agree on a purchase price when the contract is signed.
In other situations, the price is determined when the lease expires, based on the property's then-current market value. Many buyers prefer to “lock in” the purchase price, especially in markets where home prices are trending up.
The Bottom Line
A rent-to-own agreement allows would-be home buyers to move into a house right away, with several years to work on improving their credit scores and/or saving for a down payment before trying to get a mortgage. Of course, certain terms and conditions must be met, in accordance with the rent-to-own agreement. Even if a real estate agent assists with the process, it’s essential to consult a qualified real estate attorney who can clarify the contract and your rights before you sign anything.
Excerpted from an article on Investopedia by Jean Folger. For the full story click here.