Rent-to-own leases are not a new concept by any means. But as the younger generations come into adulthood and start to think about trading in renting for homeownership, a rent-to-own lease might start to look like an attractive option in the current seller’s market. Saving up to buy a home can be tough, especially when you’re just getting started on your own and might have an entry-level income and/or a lot of student debt. It might also sound like a great scenario if you’re self-employed or freelancing, have little to no credit, or have a high debt-to-income ratio. Tacking on a little extra money when you write out your rent check each month so you can eventually own the home you’re renting? It seems like a dream! If you’re not educated on the finer points of renting-to-own, however, it could actually turn out to be more like a nightmare.
What Exactly Is a Rent-to-Own Lease?
Also known as a lease-purchase agreement (among other labels), a rent-to-own lease is a contract in which a tenant agrees to rent a home from a landlord with the intent to buy. The tenant and landlord agree upon a price, which stays fixed throughout the term of the lease. Each month, the tenant pays enough to cover the agreed-upon rent plus some extra for the landlord to put away toward the purchase of the home. As an example, let’s say a tenant enters into a lease-purchase agreement for a $1890,000 home. The landlord might ask them to pay $1,000 as a down payment, and then $1,375 a month. Of that monthly payment, $1,000 would cover rent, and then the extra $375 would be put aside to contribute to the tenant’s down payment. After two years, the tenant will have $9,000 in their down payment fund, which is 5 percent of the home’s value, enough for an official down payment on a mortgage should they choose to move forward with purchasing the home.
What's the Down Side? What Are the Risks?
While this sounds like it would work out for everyone in a perfect world, it’s not without its pitfalls and risks. First, rent-to-own leases can be expensive. They’re almost always written in the seller’s favor in order to protect their interests. The landlord might require a non-refundable option premium to secure the tenant’s option to buy. While the amount can be negotiated, the standard is typically about 5 percent. The risk here is that if the tenant chooses not to buy or simply cannot do so at the end of the contract, they won’t get that money back. Additionally, there could be terms in the agreement that state that one late payment will result in a voided contract, meaning the tenant would lose all that money they’ve paid into potentially buying the home and any money they might have already put into repairs or renovations. For this reason, among others, tenants should always consult a real estate professional or attorney before they accept any contract terms. There’s also always a risk that the owner could default on their mortgage and go into foreclosure, leaving you high and dry and in the position of having to sue for remedy.
What Are Some Red Flags to Watch Out For?
The home should be in good condition. Neglect is a major red flag, so check to make sure it hasn’t been foreclosed on or isn’t in the process of being reclaimed by the bank. The landlord should also be completely cooperative when you ask to have an inspection and appraisal done. Any argument from them could mean they’re hiding something from you. Be sure your extra payments add up to the agreed-upon down payment amount. There could be a shady landlord out there counting on the possibility that his or her tenant won’t go behind them and check the math or get professional help on their side. You should also have a title check done to be certain that the landlord is the legal owner of the property. Be sure there aren’t any liens or judgments against the property that you might unknowingly take on once you become the owner. This is something you’ll need to do when you enter the contract and before it’s completed; you never know what circumstances might have changed during the term of the lease.
Proceed with Caution
If you’ve decided that a rent-to-own lease is your best option for becoming a homeowner, your first order of business is to protect yourself. Enlist the help of a real estate professional and an attorney before you take a single step forward. Different states have different laws when it comes to tenants’ rights and lease-purchase agreements. There’s certainly a plethora of information out there on the internet, but even if you consider yourself to be particularly research-savvy, you need a pro on your side. An attorney can help you with the fine print and rewrite a contract to tip the scales more in your favor. They can help you be certain that the owner can’t overcharge you or suddenly change the price of the home at the end of the contract. Once your attorney has gone over the contract and okays it, talk to a lender. They can help you go over the math and even put you through the prequalification process. That way you’ll know if you’re on the right track to getting a mortgage, or if it might even be smarter and more cost-effective to go ahead and get a mortgage and buy now.
The Bottom Line
If it’s not the right time for you to buy a home outright, you might be better off moving to a place with cheaper rent and putting aside the amount you would’ve spent beyond that into a down payment fund yourself. Then you’ll know you’re not paying more than necessary yet you’re still saving to make that down payment when the time comes. If you decide that a lease-purchase option is the best move for your situation, as we’ve stated above, proceed with extreme caution. Contact a professional as soon as possible, and make every effort to thoroughly protect and educate yourself before you sign anything.