While perhaps not as common as it once was, “rent-to-own” (or “lease option”) homes are still a popular choice for those looking to purchase a home who also have extremely bad credit or other financial issues preventing them from getting a traditional mortgage. Landlords also can be drawn to these agreements, as it’s a way to make more money than they might have otherwise with just a typical rental.
But are these deals legitimate? Are they worth it? How do they work? The following is our quick guide on all things rent-to-own.
What Is Rent-to-Own & How Does it Work?
A rent-to-own, or lease option, is a contract between the homeowner and the renter that allows the renter to purchase the home at an appointed time for a set price. This is a legal contract between the renter and landlord that must be notarized, so it’s not a scam at all; it’s legally binding and recognized. Because of this, everything must be in writing and clearly stated so it’s understood on both sides.
The renter then puts down “option money,” much like a down payment. However, while a down payment is expected to be around 20%, option money is usually only around 5%. The renter will not only pay the rent each month, but an extra monthly fee known as a lease credit. This goes toward the purchase price. After the contract ends (usually anywhere from 3-5 years), the tenant then gets a loan to purchase the home.
Purchase Price Locked. The tenant knows that the landlord cannot raise the purchase price later on down the road; whatever price was agreed upon when the contract was signed is the price it will be when it comes time to purchase the home. This is also a great deal for the renter if housing prices increase, because it means if they follow through with the contract, they get instant equity!
Might Be the Renter’s Only Option to Buy. Everyone has made mistakes with money, and because of this, some people may not be able to qualify for a traditional mortgage loan. Some people’s credit may be so bad that they can’t even find a decent home or apartment to rent. This is where rent-to-own comes in. Bad credit is allowed, so it gives people who may have made poor financial choices in the past an opportunity to turn that around…and of course, a place to live!
Gives the Tenant Time to Improve Credit. Most rent-to-own contracts last anywhere from 3-5 years. This gives the tenant with bad credit the chance to build their credit score back up, as well as an opportunity to pay towards their own home purchase (through the lease credit).
Purchase Price is Often Over Market Value.
Houses in rent-to-own deals will almost always be a pricier than others – it comes with the territory. However, that doesn’t mean the renter should be taken advantage of. Plenty of landlords are honest and decent people. Unfortunately, there are also those who may want to take advantage of the financial situation of the renter. They know this may be the renter’s only option, and so they may set the home’s purchase price much higher than that of similar homes in the area. While some renters may be in a desperate situation, that doesn’t mean they can’t have a legal representative or real estate agent look over the contract prior to signing. A good rule of thumb is if it’s priced over 20% of the fair market value, you’re probably being taken advantage of.
Monthly Payments May Get Pricey.
As mentioned, lease credit is an additional monthly fee on top of rent that the tenant must pay every month, and this may not be something the tenant can afford comfortably for 3-5 years depending on their situation. It’s also important to note that in typical rental situations, the landlord is responsible for paying property taxes, insurance, repairs, and even some utilities. However, in a rent-to-own situation, the tenant may be responsible for some or all of these costs.
Balloon Payment Must Be Paid…or Else!
A “balloon payment” is the amount that must be paid when the contract ends. It is the purchase price, minus the option money and lease credits paid over the course of the contract. Basically, the tenant must qualify for the loan amount at the end of the contract. If this cannot happen, the renter cannot purchase the home. They lose their option money and all of their lease credit as well.
How to Avoid Scams
The following is a list of things to look out for to keep you from being scammed.
- If the purchase price is over 20% of the fair market value.
- If the contract makes it easy to evict the tenant or do away with the deal entirely.
- Make sure the property is legally owned by the landlord with no liens on it. They must be up to date on their mortgage payments. If not, it’s a scam. And make sure the contract allows you access to see the owner’s mortgage receipts over the course of your contract.
- Make sure the contract allows for a reasonable late period to make your payment. (10 days is average.)