When buying a home, getting a mortgage is usually the first option that comes to mind. But what if you haven’t saved enough money for a downpayment?
Did you know that there is another non-traditional way of owning a house called Rent to Own? This is where you rent a house for a certain amount of time with the hopes of owning it in the future.
Sounds interesting. Right? But wait, before you get excited. It’s a bit more complicated than the normal way of renting and there are risks involved which you should be aware of.
In this article, we will cover:
- Definition of Rent to Own
- How Rent to Own Works
- Pros and Cons of Rent to Own
- How to Find a Rent to Own House
- Basics of the Agreement
1. What is Rent to Own?
In this type of agreement, you rent a house for a specific period then later buy it from the landlord depending on the terms of the contract.
The seller gets a fee, known as the option fee or option money which gives you the option of buying the house once the lease expires. This fee is non-refundable but it is negotiable and will range between 2% and 7% of the purchase price of the house.
The seller will hold a certain portion of the rent money as equity for buying the house.
There are 2 types of rent to own agreements:
Lease option: There is an option of buying the house once the lease agreement expires. If you change your mind, you can always move to another house with no obligations to the landlord.
Lease purchase: It is a legally binding contract where you are obligated to buy the house at the end of the lease whether you can afford it or not. It is usually hard to get out of this type of contract.
2. How Does Rent to Own Work?
There is no one size fits all when it comes to the rent to own process. However, most processes will entail:
The seller states the price of the house either at the start of your lease before you sign the agreement or when the lease expires.
The price of the house is based on the home’s current value. A house could either appreciate or depreciate by the time you are ready to purchase it.
Most buyers will want to decide on the purchase price before they move into the house to know what they’re working with and to avoid paying more if home prices in that location rise.
When signing the contract, you agree on the amount of rent to pay each month. Your rent will be slightly higher than the other tenants because a portion of it, which is referred to as rent credit, will go towards purchasing the home.
Rent is 25% to 30% more compared to the usual rent price of that area.
Fine-tune these details beforehand to avoid having any misunderstandings with the landlord as time goes by.
Sellers are usually responsible for taking care of their property. But in a rent to own agreement, some will transfer the maintenance responsibility to you because technically you will end up owning the house so it will be your responsibility.
Because rent to own is a unique situation, the contract needs to state who does what in terms of maintenance and paying taxes such as property tax, insurance and more.
Buying the House
When the time comes to buy the house, mortgage financing will go a long way towards paying off the balance of the house. A mortgage adviser will inform you of the different options available and explain how the mortgage application process works.
When you sign the lease option contract and the lease expires, there is no obligation on your end to purchase if you happen to change your mind. Unfortunately, you will lose the option fee and any money paid up to this period.
Additionally, the lease purchase contract can get complicated if you are unable to raise the money to buy. Because the contract is binding, you’ll be forced to look for funds to purchase the house.
Is rent to own the right way to go? Let’s find out the pros and cons.
3. Pros and Cons of Rent to Own
There are both upsides and downsides to investing in rent to own homes. You might be hearing more of one side compared to the other. However, if this is the route you want to take, here are some reasons why you should consider it.
- Your credit score will improve while still renting
- You can test the house and neighbourhood beforehand
- Equity grows as payments accumulate
- The purchase price won’t change even if market prices rise
- Requires you to pay a non-refundable upfront fee
- Rent is more expensive compared to the standard way of renting
- You might have to pay for maintenance and repairs
- The home value could go down which means paying more than what the house is worth
- If you don’t pay rent on time, you could lose the option of buying the property altogether
4. How to Find a Rent to Own House
It’s not common to find rent to own houses compared to finding houses for rent and sale. They are usually available:
- If the landlord is having trouble selling a house and puts it up as a rental with the option of rent to own.
- If the landlord wants to sell their property and the tenant loves it that much that they end up wanting to buy.
- If homebuyers approach landlords and propose the idea.
5. Basics of the Agreement
Before signing the contract, understand both contract types and their implications. It is better to sign a lease option agreement to avoid being legally bound to buy a house.
Find a good property lawyer to explain the terms of the contract and what to expect. Some of the important points to take note of in the contract are:
- The option fee
- Rent payments
- The purchase price
- Who is responsible for maintenance and repairs
- Durations and deadlines for making payments
- Property taxes are already paid on the house
Before you commit to this type of investment, doing due diligence and researching on the landlord/seller puts you in a better space and well-armed with the right information to make an informed decision. Find out how long they’ve owned the property and if the title deeds are readily available.