Call Us Today: 1-832-205-8800

Is Rent To Own a Good Idea? What It Is and When It Makes Sense, Explained

Is rent to own a good idea? It depends on several factors. We break down when it’s a good idea and when it’s a bad idea for you, based on expert advice. —-

You’re being presented with a rent-to-own opportunity, but although you’ve heard of rent-to-own homes, you’ve never really considered it before. Rent-to-own might be a good idea and a great way to get you into homeownership, but is it too good to be true? Will it be a good fit for your household?

Whether or not rent-to-own might be the perfect solution to your house-hunt depends on several factors. These include your financial position, the home itself, the housing market, and what your life looks like now as well as what it’s likely to look like in a few years.

You’ll need to understand what rent-to-own means, both generally and for your specific opportunity, so to make it easy for you, we queried the experts and are breaking it down for you. Keep your rent-to-own opportunity and circumstances in mind as you go through the points below to decide whether you should jump on this house or keep looking.

Here are a few things to consider when making your decision.

Source: (rupixen.com / Unsplash)

Understanding the rent-to-own basics

Rent-to-own contracts are their own unique beasts and can contain surprises for the uninitiated. If you’re considering a rent-to-own house, you need to have a clear understanding of how these contracts work — they’re a little bit different from both a typical rental contract and a typical home purchase contract.

Term lengths

The term length for rent-to-own contracts can vary from between one and five years but is typically either one or two years. Check your contract so you’re clear on how long you’ll be paying rent before you (maybe) switch to paying a mortgage.

When the future purchase price is set

The price for a rent-to-own home is generally set when you start renting and is usually a bit higher than the current market rate to accommodate for expected future price growth.

If the housing market is strong and prices keep going up beyond what’s anticipated, this could mean you start your homeownership journey with some equity stacked up. On the other hand, if the economy is wobbly, setting a price in advance could work against you.

You may be able to agree to set the purchase price when the lease expires, but not every landlord-seller will agree to that, and it could present some risk to you as a buyer in the event that you’re priced out of the market during your lease term.

Lease option vs. lease purchase

These are two very different situations, and you should be aware of which one is listed in your contract.

A lease option agreement gives you the opportunity to buy the house you’re renting before the lease is up, but you can choose not to do so, though you may forfeit some fees by backing out.

A lease purchase agreement means you are obligated to buy the house you’re renting.

If you’re not 100% sure you want to buy the house, make sure your contract is a lease option agreement, not a lease purchase.

Option fee

Also called “option money” or “option consideration,” this fee is the amount of money you pay when you sign the contract to reserve the first option to buy the house when the contract term ends. This amount is typically non-refundable if you decide to walk away from the purchase, but it will be credited toward your down payment if you purchase the house.

The amount of the option fee is negotiable; there is no standard rate, but an option fee usually ranges from between 1% and 7% of the agreed-upon purchase price. You will be expected to pay the option fee when you sign the rent-to-own contract.

Forced down payment savings through ‘extra’ rent

In a rent-to-own agreement, you’ll most likely be paying more than the market rental cost on the home. This is what’s called a rent premium. The landlord-seller will apply that extra money toward your down payment when you buy the house. You’ll know upfront when you sign the contract exactly how much extra you’re paying every month that will be credited towards your down payment.

For example, if you’re paying $1,400 per month, and 25% of that ($350) goes toward your down payment, then in two years, you’ll have put aside $8,400 in rent credit.

Keep in mind that this money may also be forfeited if you choose not to buy the home. Double-check the terms of your contract so you’re clear on what happens to that extra money if you decide to walk away from the deal.

Who’s in charge of maintenance?

You want to have a clear understanding about who is in charge of maintenance during your lease period. Often, it’s you as the buyer.

However, sometimes landlords choose to retain the responsibility of paying for any necessary repairs and maintenance, as they’re still responsible for things like homeowner association (HOA) fees, insurance, and taxes during the lease period.

Even if your landlord is covering maintenance of the property, make sure you have your own renters insurance policy to cover your belongings. You might also want to have a conversation with your landlord-seller about their liability coverage for the home in case someone is injured in the house to ensure that your financial investment is protected.

What happens if you’re late with payments?

In some cases, a single late payment can violate the contract and negate your ability to purchase the house. You may not lose your rental contract over a single late payment, but you don’t want to lose your chance to buy the home you’re already living in and love.

Be very clear about any penalties associated with late payments, whether they’re late fees or losing the ability to buy the house.

Source: (Emil Kalibradov / Unsplash)

Renting-to-own may be a good idea when …

Renting-to-own is a growing real estate trend, and there are several reasons why. Many center around making homeownership more accessible to younger people who are starting out in life or those who have hit a few hiccups and need a little time to get things in order.

Rent-to-own can be a great idea when:

You know and trust the seller already

Rent-to-own deals have the potential to be scammy if you’re not careful, but if you have an existing relationship with the seller, then you can tweak the contract to benefit everyone. This is especially true if the seller’s situation is leading them to prefer a rent-to-own contract over an outright sale.

That relationship and foundation of trust should translate to better communication and the ability to reach a deal that you’re all happy with. Neither of you will need to worry that the other one is taking advantage.

You need time to repair your credit

If you’ve had some financial hiccups, and your credit score reflects that, taking the time to improve your credit with timely payments or decreasing your outstanding credit balance could help you get a better deal on your mortgage loan.

A better mortgage loan will translate to long-term savings. Plus your improved credit could go on to positively impact your finances by lowering interest rates on credit cards.

You need time to reduce your debt

Just like your credit score, your debt-to-income (DTI) ratio is going to determine what your mortgage buying power looks like and if you’re even able to qualify for one!

If your DTI Is too high (most lenders want to see ratios below 45%, including the new mortgage payment, though some buyers can qualify for a mortgage loan with a DTI as high as 50%), then you may not qualify for a mortgage right now. If your DTI is between 36% and 45%, you may want to take steps to lower it to qualify for a larger mortgage, especially if your down payment savings are on the smaller side.

You could use help saving for a down payment

If saving up for a down payment is hard for you, then having someone else effectively help you save up could be a great strategy. Because a rent-to-own agreement has your landlord putting aside some down payment money out of your rent, you don’t have to think about it or have the option to spend the money elsewhere — like on new toys or a trip. By default, you’ll have earmarked and saved the down payment.

Because you’ll be living in the house for a year or two before you buy it, this will also give you time to explore down payment assistance programs in your area and see whether you qualify for a grant or a loan to help boost your savings.

That said, most rent-to-own buyers will want to save additional funds beyond these forced monthly rent savings in order to get the best deal on their mortgage; you’ll probably want to think about doing the same thing.

You know you love the house

If you love the house, it may be worth committing to it in a smaller way before committing to a 30-year mortgage. Think of it like moving in together with a partner before getting married. You’ll get to see if you are really as perfect a match as you believe and, if so, you have the option to stay together long-term.

Buyer competition is fierce in your area (and you don’t want to deal with it)

Buyer competition can be one of the hardest things about trying to buy a house — every time you find a great house, another buyer swoops in faster than you, or offering more money.

In a rent-to-own situation, you won’t have to jockey against other buyers for this house — you’ll already have dibs on it! Not every buyer wants to delay their home purchase but if you’re willing to do so, you can nab a great home without the buyer competition.

You need to move in immediately

Closing on a home can be a slow, tedious, and exhausting process. Did we mention it can take weeks, or even months?

If you’re trying to move in immediately, you can’t afford delays. By renting the house now with the understanding that you intend to buy it, you can make the process less stressful for yourself. You’ll immediately have housing, and you’ll be able to buy the home in a more relaxed way, when you’re not in a time crunch.

You’re confident you’d be able to get a loan when the rental period is over

If whatever is holding you back from qualifying for a loan now is definitely going to be resolved in the next year or two, then committing to a home now can be a great idea, especially if your dream home is on the market and the owner is willing to enter a rent-to-own agreement with you.

Rent-to-own can be a great stopgap solution when your finances are temporarily wobbly, like if you’re going through a divorce or returning from a stint abroad and in the process of shifting your assets back to the United States.

Source: (Dimitri Karastelev / Unsplash)

Rent-to-own is probably a bad idea when …

While rent-to-own can be a great option for many potential homebuyers, there are circumstances where it just doesn’t make sense.

It’s a lease purchase agreement

A lease purchase agreement legally obligates you to buy the home, so you’re stuck with the commitment and the cost of rent during your lease.

If something changes in your circumstances, you’re still legally on the hook for buying the house, which can be a very expensive headache.  

You’ll definitely lose your option and monthly fees if you decide not to buy

Will you get your down payment money back if you don’t buy the house? If the landlord-seller is going to keep it all, that’s likely not a great deal for you.

If this is in the rent-to-own contract, see if you can negotiate these details. Even if you’re sure you’re going to buy the house based on your circumstances and plans right now, both circumstances and plans can change, and you don’t want to be out thousands of dollars if they do.

You can’t afford to pay higher-than-average rent for the market

Part of this amount is going toward your down payment, but that’s moot if the total amount is out of your budget.

You may be better off saving money toward a down payment in another way — even by just stashing what you can afford to put aside in a high-yield savings account of your own.

You won’t be able to afford higher mortgage interest rates

We’re not sure what will happen with rates exactly, but many experts agree they will probably rise in the next couple of years, and that could have a big impact on affordability in some areas. If your mortgage plans rely on interest rates remaining at current or lower levels, and you won’t be able to afford the mortgage if they rise, think twice before you sign on the dotted line.

The economy fluctuates, and rates change. You may be unpleasantly surprised when it comes time to get your mortgage.

Source: (Clayton / Unsplash)

What are some alternatives to a traditional rent-to-own agreement?

If you need a little help buying a house, but the traditional rent-to-own agreement isn’t right for you, you still have some options to get you to homeownership.

Startups offering wider options

New platforms like Divvy Homes can make it easier for aspiring homebuyers by prequalifying them for a mortgage loan and giving them a set budget. Divvy clients select their home and pay between 1% and 2% as a down payment/option fee. Divvy buys the house in cash and covers all necessary fees, closing costs, taxes, and insurance, and then rents it to the client.

Clients can immediately move into the home and begin building up equity with their monthly payments. Most  Divvy clients are able to qualify for a traditional mortgage within three years.

Because Divvy enables their clients to shop on the open market, buyer competition can still be a challenge.

Explore first-time buyer programs

First-time home buyer programs offer grants or loans to make it easier for those who are going through this process for the first time and might need a little help.

William Frohriep, an agent in Macomb County, Michigan with over 50 years of real estate experience, often advises clients to look at local programs:

“If you’re a first-time homebuyer in Michigan, we have a number of programs where buyers can get a certain amount of money, and they can use those funds toward a down payment on the house, so they don’t need a lot of cash of their own.”

Most states have their own first-time homebuyer programs, usually geared to help with the down payment or closing costs (or both), in order to encourage property ownership.

Consider paying for mortgage insurance

If what you’re missing is the ability to collect 20% down, then a loan with mortgage insurance may be a smart option for you.

Private mortgage insurance is required on conventional loans where buyers are putting less than 20% down on the house; it is insurance for your mortgage payments, not for the house itself. How much your mortgage insurance costs will depend on several factors, which include your credit score and the loan-to-value (LTV) ratio, which is the amount owed on the home relative to its stated value. Usually, you’ll pay between 0.5% and 1% of the loan amount annually.

Mortgage insurance payments are wrapped into your mortgage payments and you will typically only need to pay for mortgage insurance until you’ve paid off 20% of your home’s value, at which point you can cancel it (though there are some exceptions with FHA loans). Mortgage insurance payments don’t have to be a long-term expense; they just give you a little breathing room around how much you need to have saved up for your down payment.

Talk to a loan originator about an FHA or USDA (or VA) loan

Having a FHA or USDA or VA loan may allow you to put less money down with a lower credit score and still get your foot in the homeownership door today.

These programs have eligibility requirements — but if you’re eligible, they’re incredibly helpful, so it’s worth spending the extra bit of time to find out if you are. Your loan originator will be able to tell you, so be sure to ask.

Jeffrey Zhou, Co-Founder & CEO of FigLoans, encourages his clients to consider FHA loans because “while it’s often difficult for many people to save enough money for a down payment,” FHA loans can offer a quicker path to homeownership and building equity.

Whether or not rent-to-own is a good idea for you is going to depend on variables that only you understand. Talk to a market expert like a real estate agent to see what your options are and whether rent-to-own is among the best ones for you.

Header Image Source: (Aaron Sousa / Unsplash)

–Shared with love by the Valmy Team– your Texas realtor team. We would love to earn your trust and partnership, www.TheValmyTeam.com. All content copyright by the original authors.

Share This