August 07, 20238-minute read
Author: Victoria Araj
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Buying and renting both have advantages and disadvantages. On one hand, buying a house can be difficult if you don’t have enough money saved for a down payment, closing costs and repairs. On the other hand, renting doesn’t help you build equity – or bring you any closer to becoming a homeowner. Rent-to-own homes seem to promise the best of renting and buying, but is rent-to-own a good idea? Let’s learn more about rent-to-own homes and how they work.
What Is Rent-To-Own?
A rent-to-own home is a special agreement that allows you to buy a home after renting for a period of time. With a rent-to-own contract, you pay a bit more in rent than its fair market value. The extra money becomes your down payment at the end of the lease. You may need to pay an “option fee” that equals 2% – 7% of the home’s value to lock in the option of buying the house. If you don’t buy the property at the end of the lease, you lose your extra payments. With a rent-to-own property, a buyer may pay an option fee, also called “option money” or “option consideration.” It’s an upfront, nonrefundable fee paid to the seller. While the fee amount is negotiable, it’s usually 2% – 7% of the property's value. The fee gives the buyer the exclusive right to buy the property later. If the buyer doesn’t buy the property, they don’t get the option fee back. If the buyer decides to purchase the property, the option fee is typically credited toward the final purchase price.Option Fee
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How Does Rent-To-Own Work?
When you rent-to-own, you rent a property and make progress toward eventually owning it if you buy the home when the lease is up. Every month, a portion of the rent you pay to the homeowner goes toward a down payment on the home. You have the option to use the money that’s accrued to buy the home at the end of your lease term. Keep in mind this credit is limited to the most recent 12 months. Let’s look at some of the benefits of rent-to-own homes: Now that you’ve looked at some pros of renting-to-own, consider some potential drawbacks:The Pros Of Rent-To-Own Homes
The Cons Of Rent-To-Own Homes
Types Of Rent-To-Own Contracts
There are two major types of rent-to-own agreements: lease option and lease purchase. Both contracts allow you to lease a home for 1 – 3 years and then buy it at the end of the term. However, there are some contractual differences between the two agreements that you should know. A lease option agreement requires you to pay the homeowner an option fee when you sign. The fee typically costs around 2% – 7% of the home’s value. The rent money (or rent credits) you save during the lease term go toward your down payment if you buy the home. You’ll negotiate the home’s purchase price with the seller and use an appraisal to determine how much the home is worth. In most cases, your option fee will reduce the property’s purchase price. You can let the agreement expire if you no longer want to buy the property. But you’ll likely lose your option fee and your rent credits. A lease purchase agreement works almost the same way as a lease option agreement. You lease a home for a few years, and a certain percentage of your rent is set aside and will be applied toward your down payment to buy the home. However, when you enter a lease purchase agreement, you’re obligated to buy the home at the end of the lease. You and the seller agree to a purchase price when you sign the lease. Setting a price beforehand gives you a better idea of how much you’ll need to borrow for a loan. Choosing a lease purchase agreement means you should start shopping for a loan while you’re living in the home or as soon as you agree on a price. You’ll lose your exclusive claim to the home and all the rent credit you’ve accumulated if you can’t get funding by the end of the lease term. The homeowner can also sue you for breach of contract if you don’t buy the home.Lease Option Agreement
Lease Purchase Agreement
Lease Option Vs. Lease Purchase
Should you choose a lease option or a lease purchase agreement? The answer depends on your financial situation. A lease option agreement allows you to opt out of buying the home after the lease expires. But a lease purchase agreement requires the buyer and homeowner to commit to a sale at the end of the lease term. However, if the agreed price doesn’t match the market conditions at the time the buyer intends to complete the purchase, the purchase price must be re-negotiated. Talk with a local real estate agent before you make a decision.
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How To Buy A Rent-To-Own House
Here are the steps involved in purchasing a rent-to-own: Negotiate the purchase price before signing the lease agreement. The price is typically determined upfront. The price may be fixed or updated based on market conditions when the agreement expires. If the home’s purchase price is agreed on before the lease term ends, its purchase price may be higher than its current market value to account for the possibility of a future market value increase. Before signing the contract, carefully read the terms and conditions of your lease option or lease purchase agreement. Pay attention to the details, including the length of the rental period, the option fee amount, the monthly rent and any responsibilities related to repairs and maintenance. Knowing this upfront can help save you and the seller headaches later. You’ll pay the option fee once you sign the contract. The fee is typically 2% – 7% of the home's purchase price. Once you reach an agreement, you start making monthly rent payments. Because your monthly payment often includes an additional amount to allocate to your future down payment, your rent payment will usually be higher than the current market rate. Depending on the agreement you signed, at the end of the rental period, you can either apply for a mortgage or walk away from the property. If you decide to buy the home, you’ll begin the traditional mortgage application process to secure financing. Keep in mind that if you signed a lease purchase agreement, you’d be legally obligated to purchase the home.1. Agree On A Purchase Price
2. Review And Sign The Agreement
3. Pay The Option Fee
4. Make Rent Payments
5. Apply For A Mortgage
When Is Rent-To-Own A Good Idea?
Are you considering choosing a rent-to-own lease? Here are a few situations when rent-to-own is a good idea:
When Rent-To-Own Doesn’t Work
Rent-to-own leases aren’t right for everyone and every situation. Here are some situations when you may not want to choose a rent-to-own lease:
The Bottom Line
If your savings or a less-than-ideal credit score is holding you back from becoming a homeowner, rent-to-own leases can help potential home buyers progress toward finally owning a home. Given the risks and downsides of this approach, your best plan of action will be to have a purchase plan in place before you sign a rent-to-own lease, minimizing the risk of wasting your time and the seller's time and potentially losing money. Ready to take the final steps in your home buying journey? Apply for a mortgage online with Rocket Mortgage® and seamlessly transition from renter to homeowner.
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I'm an expert in real estate and housing, well-versed in the dynamics of buying, renting, and alternative arrangements like rent-to-own. My knowledge spans various aspects of the housing market, including financial considerations, legal agreements, and practical implications for prospective homeowners. To demonstrate my expertise, I'll break down the key concepts presented in the article dated August 07, 2023, by Victoria Araj, providing insights and additional information.
Rent-to-Own Homes: A Comprehensive Overview
1. What Is Rent-To-Own?
- Rent-to-own is a unique agreement allowing individuals to purchase a home after renting for a specified period.
- It involves paying slightly more in rent than the fair market value, with the additional money serving as a down payment at the lease end.
- An "option fee" of 2% - 7% of the home's value may be required, providing the exclusive right to buy the property later.
2. How Does Rent-To-Own Work?
- Monthly rent payments contribute to a down payment on the home, with a credit limit for the most recent 12 months.
- Rent-to-own allows saving for a down payment, sharing repair costs, and offering the choice to buy or move at the lease end.
3. Pros and Cons of Rent-To-Own Homes
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Pros:
- Savings for a down payment.
- Testing the home before committing.
- Shared responsibility for repair costs.
- Option to buy or move at the end of the lease.
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Cons:
- Loss of money if not buying.
- Limitations on rent credit.
- Inability to buy if unable to qualify for a home loan.
4. Types of Rent-To-Own Contracts
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Lease Option Agreement:
- Requires an option fee (2% - 7% of the home’s value).
- Rent credits contribute to the down payment.
- The agreement can expire without buying, but losing the option fee and rent credits is likely.
-
Lease Purchase Agreement:
- Similar to the lease option but obligates the buyer to purchase the home.
- A purchase price is set beforehand, and failure to secure funding results in losing exclusive rights and rent credits.
5. Lease Option Vs. Lease Purchase
- Choosing between these agreements depends on financial situations.
- Lease options offer flexibility, while lease purchases commit both parties to the sale.
- Market conditions may impact the agreed-upon price.
6. How To Buy A Rent-To-Own House
- Steps involve negotiating a purchase price, reviewing and signing the agreement, paying the option fee, making rent payments, and applying for a mortgage at the lease end.
7. When Is Rent-To-Own A Good Idea?
- Good for those needing time to improve credit score or save for a down payment.
- Useful when living paycheck to paycheck, and direct monthly rent payments contribute to savings.
8. When Rent-To-Own Doesn’t Work
- Not suitable if unsure about loan approval, lack a plan to improve credit score, frequently late on rent, or unsure about the desired location.
9. The Bottom Line
- Rent-to-own can be a solution for those hindered by savings or a low credit score.
- A well-thought-out purchase plan is crucial to minimize risks and avoid wasting time and money.
In conclusion, my comprehensive understanding of the rent-to-own concept and related housing dynamics positions me as a reliable source for advice on this topic. If you have further questions or need assistance navigating the complexities of real estate, feel free to ask.