Rent-to-own has become a popular way to buy a home in recent years. After the housing crisis, many consumers left with damaged credit. Unable to secure a mortgage approval, they were stuck renting. Many renters, however, got smart and signed an agreement to buy the home after a specific period of renting. Three years was the norm.
Once the three years was up, renters could buy the home and become the actual homeowners. It sounds great, but is it the right program for you? We look at the pros and cons below.
How Does Rent-to-Own Work?
When you rent-to-own, you sign a lease contract that shows the option to buy the home. Generally, you pay a deposit first, usually around $5,000. The contract then specifies the amount of rent and the rent premium. The rent is the usual rent you would pay even if you weren’t buying the home. Rent premium, is the money the owner puts towards your down payment.
For example, let’s say your rent is $1,000 and your rent premium is $500. This means you pay a total of $1,500 per month. Over the course of one year, you’d pay $6,000 towards your down payment. If you exercise your right to buy the home, the total paid in rent premiums is used for your down payment.
The contract you signed has a predetermined purchase price for the home. Once your rent period is up, you have the option to buy the home for that price. If prices increased, it can work in your favor. However, if prices decreased, it could be difficult to secure financing.
Do You Have to Buy the Home?
Something many people wonder is if you have to buy the home. You don’t. But, it makes financial sense to do so. The deposit you paid is likely non-refundable as are the premiums paid. If you rented for say 2 years with a $500 premium, that’s $12,000 gone.
So you don’t have to buy the home, but it usually pays to do so. If you decide within the 1st year that you won’t buy the home, let the landlord know. This way you can cancel the rent-to-own contract and save yourself a lot of money.
What are the Advantages of Rent-to-Own?
Typically, buyers that don’t have great credit or enough cash for a down payment benefit from rent-to-own. There are a variety of reasons:
- It gives you time to bring your credit score back up
- It allows you to lock in a purchase price in a rising market
- It allows you to “test” living in the area to make sure you like it
- It gives you time to save for the down payment
If you found your dream home, but you can’t afford it yet, this option can work in your favor. Of course, you have to find a willing seller, though. Not all sellers are keen on keeping the property for a few more years.
What are the Disadvantages of Rent-to-Own?
Of course, there are downsides of the process as well. Most of them have to do with money too.
- You stand to lose any money you paid into the home if you can’t secure financing
- The seller can make it difficult for you to buy the home, forcing you to lose your money
- The owner could still lose the property in foreclosure unless he owns it outright
- You might end up paying more than the home is worth if values fall
What Should You Do?
No one can tell if rent-to-own is right for you. Only you know that answer. Ask yourself the following questions:
- How long will you stay in the area? If it’s a long time, this process can make sense. If you only plan to live here for a short while, renting might be the more sensible option.
- Have values increased or decreased in the area lately? In a case of rising values, it may make sense to lock in the purchase price now. If prices haven’t increased, though, it doesn’t make sense to lock in a price now.
- Can you secure a pre-approval for financing? You shouldn’t sign a contract until you know there’s a chance you can secure a loan. If you can’t secure one now, you might not be able to in the future. That’s a big gamble.
Make sure you look at all of your options. Rent-to-own can work well when you are in the right situation. If everything isn’t perfect, though, you could stand to lose a lot of money.
Talk to your real estate agent and your lender. See what they think of the situation. If they agree that you’re in a good position, go for it. If not, you can always save the “rent premiums” you would have paid in your own savings account. After a few years, you should have a decent down payment to buy a home. Remember, it only takes 3.5% to buy a home with FHA financing.Click to See the Latest Mortgage Rates»