Pros and Cons of Rent-to-Own Homes
This blog explains rent-to-own homes, where you rent with an option to buy, detailing the process, negotiation, rent credits, fees, and pros (credit improvement, price certainty, trying before buying) and cons (higher rent, non-refundable fees, potential mandatory purchase) of this arrangement.
Many people dream of owning their own home but worry that getting the down payment together is simply out of reach. For some folks, one option for working your way into the housing market might be a rent-to-own home: a rental house that you eventually purchase. There’s a lot to consider, though. Here are the basics.
How the Rent-to-Own Process Works
In a rent-to-own agreement, you typically rent a home with the option to buy at a predetermined price within a specific timeframe, usually between one to three years. To get started, you need to find a property owner who offers this arrangement or work with a real estate agent.
Once you've found a place, the next step is to negotiate the terms with the owner, including:
- Monthly rent amount
- Rent credit amount (percentage of rent that goes toward the eventual down payment)
- Purchase price of the property
After you begin renting, a portion of your monthly rent starts to accumulate as “rent credit,” building up your down payment for the future purchase. The purchase price can be based on the property's current market value or a predetermined price set in the contract.
Option to purchase vs mandatory purchase
When the rental period is up, you'll have the option to purchase the property at the agreed-upon price using the accumulated rent credit as part of your down payment. During the rental period, it's crucial to take good care of the property as your own. If you decide not to purchase, you may be able to simply move out at the end of the rental agreement, depending on the details in the agreement.
However, some rent-to-own agreements include a mandatory purchase clause, which requires that you buy the property at the end of the option period. If you choose not to complete the purchase, you may need to pay a penalty. Be sure you understand the details of your agreement before you sign it.
How Rent Credits Add Up
The specific amount of rent credit per monthly rent payment varies according to the terms negotiated between you and the owner. Usually, a percentage of the monthly rent, such as 10-20%, is designated as the rent credit.
For instance, you pay a monthly rent of $1,000 and the agreed rent credit is 15%, so each month, $150 would be credited towards the purchase of the property.
What to Know About Option Fees and Option Periods
Usually in a rent-to-own agreement, an “option fee” is required upfront. In exchange for this payment, the owner grants you the first option to buy the property after a specified rental period. Typically, the fee is a percentage of the home’s purchase price and is often credited towards the purchase price if you decide to buy the property. It may or may not be refundable (as always, make sure you understand – and are comfortable with – your agreement before signing).
The agreement also includes an “option period.” This is different from the rental period. It’s the timeframe during which the tenant has the exclusive right to purchase the property. Usually agreed in advance in the contract, it can last from several months to several years.
What to Know About Market Conditions and Property Values
In a rent-to-own scenario, the tenant and owner typically negotiate and agree on the home’s purchase price at the beginning. So, while the agreement may allow for renegotiation if the purchase hasn’t been completed after a certain period of time, usually the price you negotiate originally is the price you pay, even if the value of the home has changed in the intervening years.
Get the property inspected
It’s a good idea to get the home appraised and inspected before signing the rent-to-own agreement with the owner. A home inspection reveals the condition of the home and any potential repair or replacement costs coming your way. The appraisal tells you if the asking price is fair.
Read the Rent-to-Own Fine Print
It’s crucial that you read the agreement very thoroughly, so you don’t get stuck with fees or repairs you didn’t realize you were responsible for. Also make sure you understand if you’re able to walk away from the property if you decide not to buy it. Here are some of the key things to look for in your rent-to-own agreement.
Hidden fees or additional costs
Rent-to-own agreements are highly variable. It’s possible there could be costs your landlord tries to pass off to you—outside of the standard fees noted above.
Maintenance and repair responsibility
Some owners might require that you handle all maintenance and repairs on your own. Others act as a more traditional landlord and continue to manage those responsibilities for you. Make sure you know what you’re getting into before you sign the agreement and factor that into your decision.
Making improvements or renovations
The property owner might allow you to make improvements, but you’ll need to work out those details ahead of time. The more likely that you’ll buy the home (you have a mandatory purchase clause, for instance), the more likely you’ll have more autonomy over the property. But that needs to be spelled out in the agreement.
Final Pros and Cons to Consider
- Rent-to-own is good for homebuyer hopefuls who don’t qualify for a mortgage right now or lack sufficient funds for a down payment. The process functions almost as a home on layaway, giving you time to improve your credit and build a down payment.
- Price certainty. The purchase price is determined at the beginning of the agreement, which can be beneficial if property prices are expected to rise.
- Try it before you buy it. Renting the property first gives you the opportunity to live in the house and decide if it suits your needs before committing to the purchase.
- Higher rent. Since part of the rent is going toward an eventual purchase price or down payment, the monthly rent is usually higher than a comparable normal rental property.
- Non-refundable option fee. Most agreements include a non-refundable option fee. If you don’t buy, you lose this fee.
- Purchase may be required. Depending on the contract, you may be required to buy the property at the end of the rental period. If your circumstances (or preferences) change, this requirement could be an obstacle.
- Price certainty, again. While locking in a purchase price can be good if prices generally go up, it can also be a disadvantage if property values go down. You may end up paying more than the property's current market value.
- Complexity. Rent-to-own agreements can be complicated. You need to fully understand the terms and conditions before entering into the contract.
If poor credit or a lack of savings has you worried that you’ll never achieve your dreams of homeownership, MMI can help. We offer free, confidential financial counseling online and over the phone. Work with a certified expert and get personalized advice.