With the dream of homeownership out of reach for many Millennials in debt, the appeal of renting to own sounds like an alternative, achievable dream. Instead of “throwing away” thousands in rent while struggling to save for a down payment, your rent money goes toward the price of the home. So people always ask, how does rent to own work?
Rent to own, which is also known as a lease purchase, is a contract between you and the seller to buy a house at a future closing date. This can be anywhere from one to three years after the contract is signed. Only 1% of first-time home buyers were renting to own last year according to the 2016 Profile of Home Buyers and Sellers published by the National Association of Realtors.
Rent to own is different than a lease option, which gives you the option to buy a place you were renting before it goes on the market, but there’s no obligation to do so. When you rent to own you usually make a deposit, which can also be called “option money,” and the contract stipulates your obligation to buy. The deposit goes to the seller and is a non-refundable fee.
There’s no standard rate for option money, which can range anywhere from 2.5% to 7% of the total purchase price of the home. If you were buying a home for $250,000 and paid a 3% option consideration, you would pay $7,500 up front. It’s smart to have that money go toward to purchase price at closing so make sure it’s included as a clause in your contract.
The contract will specify the home’s price at market value or a bit higher. Some contracts will set a price for when the lease expires based on expectations of future market value. It’s usually advantageous to set the price at the market value when you signed the contract just in case the market value increases.
The rent is usually used toward the purchase price of the home. Some contracts state that only a percentage of the rent payment goes toward the purchase price.
For example, if you’re paying $1,400 a month on rent for 4 years and 30% of that goes toward the purchase of the home, you would’ve paid $20,160 toward the purchase price ($1,400 x 0.30 = $420; $420 x 48 months = $20,160).
Your contract may state that you, as the buyer, have to pay for repairs, homeowner fees, property taxes, and insurance while renting. Other contracts will stipulate that the current owner (the seller) covers these costs. It’s important that your contract clearly state who will cover repairs, because you might get stuck fixing a water leak on a home that isn’t legally yours yet. You should still have renter’s insurance to cover any issues in the interim.
Buying the Home
If you can’t buy the home because you’re unable to secure financing and your contract said you were legally obligated to buy, you will have to go through legal proceedings. If you weren’t legally obligated to buy, then your option expires and you forfeit the money you paid.
If you want to buy the home and you successfully secure a mortgage, then you pay the seller and you become the homeowner. Congratulations!
The Pros and Cons of Rent to Own
The rent to own option is appealing to many first-time homebuyers whose credit isn’t good or who can’t afford to save for down payments. When things sound too good to be true, they usually are. So what are the pros and cons?
Pros of Rent to Own
- You don’t need to have 20% saved for a down payment before you buy. This amount is out of reach for most people who are paying off student loans and credit card debt given that the median home price is over $318,000, which means you’d put $63,600 down.
- Your rental payments act like an investment. Instead of “giving away” your rent on a home you are temporarily staying in, your rent goes toward the purchase price of the home.
- You get to try before you buy. You can live in the home to make sure you love it before you buy it.
- You can improve your credit score and save more for a down payment. If your credit isn’t great, you have a few years to pay down debt and improve your credit before applying for a mortgage.
- You could get a great deal on a home if the market value increases while you’re renting it. This is a best case scenario and one that can happen if you research locations and follow market trends.
- A well-structured contract can evenly distribute the risk between both parties so that you (as the tenant) don’t hold most of the financial risk.
Cons of Rent to Own
- The arrangements can be very complex and it requires a detail-oriented person to read through all of the fine print.
- It can be unclear who is responsible for repairs while in the rental period — is it the current or future owner? Who pays the property taxes? You need to make sure these factors are clearly stated in the contract.
- Is 100% of your rent payment being credited toward the purchase of the home or only a part of it? This will determine how much you’ll owe on the house.
- You can lose your entire investment if you miss a payment or two. With mortgages, if you miss a payment, your credit score drops and you don’t lose any of the equity on the home. With a rent to own contract, you can forfeit all of the money you’ve put toward the home.If the houses in your area start to decline in value, you risk having bought a home that isn’t worth as much as you thought.
- You also need to make sure you qualify for a mortgage in order to afford the remainder of the payments on the home. If it’s time to buy and you don’t qualify, you forfeit your option-to-buy fee and the premiums.
- If the seller fails to pay the existing mortgage, he or she may foreclose on the home and another buyer could purchase it. That would leave you searching for a new place within 30 days.
Where You Can Rent to Own
Check out websites like IRenttoOwn.com and RentUntilYouOwn.com where you can search rent to own homes. Most likely, you’ll find homes offered at a lower price than others in the market. Every state has different laws for rent to own properties and some will protect you if you fall behind on your payments due to job loss or some other scenario.
Does renting to own sound like the right choice for you? Make sure to research your options and understand your state’s laws. It’s advisable to have a real estate broker review your rent to own contract, too, so you can make sure the agreement is fair and you’re not shouldering too much of the financial burden.
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College Ave: College Ave Student Loans products are made available through either Firstrust Bank, member FDIC or M.Y. Safra Bank, FSB, member FDIC. All loans are subject to individual approval and adherence to underwriting guidelines. Program restrictions, other terms, and conditions apply. As certified by your school and less any other financial aid you might receive. Minimum $1,000. Rates shown are for the College Ave Undergraduate Loan product and include autopay discount. The 0.25% auto-pay interest rate reduction applies as long as a valid bank account is designated for required monthly payments. Variable rates may increase after consummation. This informational repayment example uses typical loan terms for a freshman borrower who selects the Flat Repayment Option with an 8-year repayment term, has a $10,000 loan that is disbursed in one disbursement and a 7.78% fixed Annual Percentage Rate (“APR”): 54 monthly payments of $25 while in school, followed by 96 monthly payments of $176.21 while in the repayment period, for a total amount of payments of $18,266.38. Loans will never have a full principal and interest monthly payment of less than $50. Your actual rates and repayment terms may vary. This informational repayment example uses typical loan terms for a freshman borrower who selects the Deferred Repayment Option with a 10-year repayment term, has a $10,000 loan that is disbursed in one disbursement and a 8.35% fixed Annual Percentage Rate (“APR”): 120 monthly payments of $179.18 while in the repayment period, for a total amount of payments of $21,501.54. Loans will never have a full principal and interest monthly payment of less than $50. Your actual rates and repayment terms may vary. Information advertised valid as of 5/18/2020. Variable interest rates may increase after consummation. Lowest advertised rates require selection of full principal and interest payments with the shortest available loan term.
ELFI: Subject to credit approval. Terms and conditions apply. To qualify for refinancing or student loans consolidation through ELFI, you must have at least $15,000 in student loan debt and must have earned a bachelor’s degree or higher from an approved post-secondary institution.
LendKey: Refinancing via LendKey.com is only available for applicants with qualified private education loans from an eligible institution. Loans that were used for exam preparation classes, including, but not limited to, loans for LSAT, MCAT, GMAT, and GRE preparation, are not eligible for refinancing with a lender via LendKey.com. If you currently have any of these exam preparation loans, you should not include them in an application to refinance your student loans on this website. Applicants must be either U.S. citizens or Permanent Residents in an eligible state to qualify for a loan. Certain membership requirements (including the opening of a share account and any applicable association fees in connection with membership) may apply in the event that an applicant wishes to accept a loan offer from a credit union lender. Lenders participating on LendKey.com reserve the right to modify or discontinue the products, terms, and benefits offered on this website at any time without notice. LendKey Technologies, Inc. is not affiliated with, nor does it endorse, any educational institution.
CommonBond: Offered terms are subject to change. Loans are offered by CommonBond Lending, LLC (NMLS # 1175900). If you are approved for a loan, the interest rate offered will depend on your credit profile, your application, the loan term selected and will be within the ranges of rates shown. All Annual Percentage Rates (APRs) displayed assume borrowers enroll in auto pay and account for the 0.25% reduction in interest rate.
Splash Financial: Terms and Conditions apply. Splash reserves the right to modify or discontinue products and benefits at any time without notice. Rates and terms are also subject to change at any time without notice. Offers are subject to credit approval.com
Earnest: To qualify, you must be a U.S. citizen or possess a 10-year (non-conditional) Permanent Resident Card, reside in a state Earnest lends in, and satisfy our minimum eligibility criteria. You may find more information on loan eligibility here: https://www.earnest.com/eligibility. Not all applicants will be approved for a loan, and not all applicants qualify for the lowest rate. Approval and interest rate depend on the review of a complete application.
Earnest’s fixed-rate loan rates range from 3.89% APR (with autopay) to 7.89% APR (with autopay). Variable rate loan rates range from 2.50% APR (with autopay) to 7.27% APR (with autopay). For variable rate loans, although the interest rate will vary after you are approved, the interest rate will never exceed 8.95% for loan terms of 10 years or less. For loan terms of 10 to 15 years, the interest rate will never exceed 9.95%. For loan terms over 15 years, the interest rate will never exceed 11.95% (the maximum rates for these loans). Earnest variable interest rate loans are based on a publicly available index, the one month London Interbank Offered Rate (LIBOR). Your rate will be calculated each month by adding a margin between 0.26% and 5.03% to the one month LIBOR. The rate will not increase more than once per month. Earnest rate ranges are current as of April 23, 2019 and are subject to change based on market conditions and borrower eligibility.
Auto Pay Discount: If you make monthly principal and interest payments by an automatic, monthly deduction from a savings or checking account, your rate will be reduced by one quarter of one percent (0.25%) for so long as you continue to make automatic, electronic monthly payments. This benefit is suspended during periods of deferment and forbearance.
The information provided on this page is updated as of 04/23/19. Earnest reserves the right to change, pause, or terminate product offerings at any time without notice.
Earnest loans are originated by Earnest Operations LLC. California Finance Lender License 6054788. NMLS # 1204917. Earnest Operations LLC is located at 303 2nd Street, Suite 401N, San Francisco, CA 94107. Terms and Conditions apply. Visit https://www.earnest.com/terms-of-service, e-mail us at email@example.com, or call 888-601-2801 for more information on our student loan refinance product.