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Should You Consider a ‘Rent-to-Own’ Arrangement When Buying?

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Housing affordability has been a big issue in California over the recent past, and there doesn’t seem to be much relief in sight for would-be homebuyers who may want to break free from the rental market and finally become owners.

But there are programs available for prospective homebuyers who might be emotionally prepared to purchase a property but are not exactly financially equipped, including rent-to-own arrangements.

What is a ‘Rent-to-Own’ Home?

In a rent-to-own arrangement – also known as ‘rent-to-lease’ – a renter signs a contract with the property owner and agrees to pay a monthly rental fee for a certain time period, which is usually anywhere between 2 to 6 years. The contract will stipulate an agreed-upon purchase price that the renter will pay to outright buy and own the home after the specified time period has elapsed. The renter is not obligated to go through with the purchase and may walk away from the deal.

During the rental period, the renter will need to upkeep the property and not make any major changes to it unless specifically permitted by the owner and written in the contract. Most of the rent paid will go towards the down payment after the contract ends.

Rent-to-own contracts should include the following components:

  • Length of the rental period.
  • Rent amount.
  • Rent credited towards the down payment.
  • How the rental credit will be held until the time of purchase.
  • What will happen to the credit should the renter choose not to buy when the contract ends.
  • Who pays the property taxes, homeowner’s insurance, utilities, and repairs during the rental period.

What’s in it For Buyers?

Save money for a down payment – The benefits of a rent-to-own program for buyers are obvious – they can move into a home that they eventually want to buy while continuing to save up for a down payment. Rather than their rent going towards paying the landlord’s mortgage off, most of the rent paid will essentially be put in their own pocket. Saving up for a down payment can prove to be extremely difficult while a good chunk of income is going towards traditional rent payments.

Boost credit rating – In addition to the opportunity to secure a home without a sizeable down payment, renters also have the benefit of working towards improving their financial situation and credit rating. In addition to not having the financial backing to purchase a home the traditional way, many homebuyer hopefuls who choose the rent-to-own route often don’t have a healthy credit score that lenders want to see before extending a mortgage. A rent-to-own home provides them with the additional time needed to make these necessary improvements. If they pay their rent on time and in full each month, they can realistically expect their credit scores to improve.

Having solid credit, a sound work history, and enough capital needed to pay for a down payment and closing expenses when buying a home is crucial when applying for a home loan. Buyers who are able to meet these requirements can significantly improve the odds of getting approved for a mortgage and even getting the best rate.

Build equity – Another added bonus is the potential to take advantage of an increase in property value. Since the purchase price is agreed upon and specified in the contract up front, renters often have the benefit of taking advantage of a rise in property values over the lease period. Should the value of the home in question be higher than the purchase price when it’s time to buy, buyers can reap the rewards of increased equity in the home.

What’s in it For Sellers?

Buyers certainly have plenty advantages to enjoy with a rent-to-own program, but why would owners be interested in taking this avenue rather that outright selling their properties?

Alleviate troubles selling – Owners usually agree to a rent-to-own contract if they’re having trouble selling their home and are highly motivated to move out.

Charge higher rent – Owners can typically charge a higher rent compared to what the current market dictates. Not everyone may have good credit or a sizeable down payment amount, but they still need a place to call home. As such, owners can ultimately increase their pool of buyers by being open to a rent-to-own arrangement.

Use rent collected towards their own down payment – Sellers who don’t have to sell their homes right away can go with this option and put the money being collected through rent towards another down payment of their own. Rental income can be earned while they work towards selling their property and buying a new one.

Higher odds of well-maintained property – Potential buyers who rent out a rent-to-own home are more likely to take better care of the property considering the fact that they’ve got an interest in it should they decide to buy when the contract expires.

What Are the Drawbacks of a Rent-to-Own Arrangement For Buyers?

Higher rental rate – As mentioned earlier, buyers will usually be charged a higher rental rate compared to what the average rent is charged to tenants. Owners view a rent-to-own arrangement as an opportunity for would-be buyers to begin the purchasing process that they otherwise probably wouldn’t be able to take advantage of. As such, owners charge a little extra for such an opportunity.

Back taxes and possible foreclosure – Buyers should also be aware that they might be on the hook for any back taxes that the current owner may have incurred. In addition, prospective buyers will not only be faced with eviction if they are unable to make their rental payments on time and in full, their homes will also be subject to foreclosure.

Lost money when forfeiting option to buy – While buyers are not obligated to buy the home once the contract expires, all that money that was paid in rent and predominantly put towards a down payment will be lost to the owner. It’s not unheard of for owners to make it unattractive for renters to go through with a purchase just to keep that money and move on to another willing buyer.

Lose equity – While it’s highly possible for property values to increase over the time period of the contract, it’s also possible for values to fall. Should the latter occur, buyers could actually lose equity in the property. At this point, they’ll be left with the option to forfeit all of their money or buy the home the traditional way. If the lender does not approve a large mortgage, more money will need to be brought to the closing table to be used for a down payment.

The Bottom Line

If you’re having trouble coming up with a sizeable down payment or are struggling with subpar credit, a rent-to-own arrangement might help. But before you sign on the dotted line, it’s crucial to weigh out the potential pros and cons of buying a home in this manner. Be sure that your contract stipulates what happens should property values increase or decrease during the lease. Talk with your lender about the nitty gritty involved in rent-to-own arrangements, and consider consulting with a seasoned real estate lawyer who will help ensure that your best interests are adequately covered in this type of contract.