Should You Try Rent-to-Own?
Following the Great Recession of 2008, lenders tightened up on requirements for buying a home. Now, not only must you have a higher credit score than a dozen years ago, you also need a higher down payment to qualify for a conventional loan.
If you have less-than-perfect credit, or lack the money required for a down payment on a home, BILLSHARK suggests you might want to consider the possibility of a rent-to-own arrangement. Such an agreement allows you to live in the home while a portion of your rent payment is applied to a future down payment on the property.
What is rent-to-own?
Although the laws can vary from state to state, basically, a rent-to-own agreement functions like a normal lease on a house. But, the renter pays a certain amount of money to the landlord with the understanding that at the end of the lease (normally between one to three years), the renter can purchase the property.
The difference between this and a normal rental agreement is the renter’s monthly rent is partly or fully applied toward the down payment.
There are generally two types of rent-to-own leases:
- lease with a purchase option
- lease to purchase
With the first type, you have the option to buy or not at the end of the lease. With the second, you are legally obligated to buy the property. If your circumstances change—you lose your job or otherwise can’t qualify for a mortgage at the end of the the term—the landlord could sue you for breach of contract.
Therefore, for your own protection, try to find properties with a lease-purchase option, rather than an obligation to buy.
“If you can’t buy it now, you may not be able to buy it later,” John Michael Grafft, a broker with Chicago’s Compass, told USNews.
One other possibility in the rent-to-own market is a landlord will offer you a multiyear lease that allows tenants to eventually pay off the home over time. Dustin Heiner, founder of Master Passive Income, a rental property investment blog and podcast, explained to USNews that he’s sold several homes this way.
“The renters do not have to get a loan or even qualify for one, but they will eventually own the home in the agreed-upon terms,” he said.
There are possible pitfalls with the rent-to-own model, however, and we want to caution you that this approach is not for everyone.
- If your credit isn’t as good as it should be to get the best terms on a mortgage, or even qualify for one at all, a rent-to-own arrangement gives you some time to improve it.
- If you don’t have enough saved for a down payment, this is a relatively painless way to get the money together.
- If the house appreciates in value while you’re in a rent-to-own arrangement, you’ll be able to buy it at the price it assessed for when you entered the agreement.
- If you’re not sure you want to buy, you’ll have the opportunity to “test drive” the house while you’re living in it to be sure it’s what you want.
- (Note: This does not apply to a lease-purchase contract.)
- You’re not tied down to a mortgage, so if your circumstances change during the course of the lease, you can move out just as you would from a rental property.
- (Note: same caution as above—with a lease-purchase contract you are legally obligated to buy the house at the end of the term.)
- Some agreements require a non-refundable deposit up front, in addition to the rent, which will almost always be higher than if you were simply renting.
- For example, if the rent on the house would normally be $1,000, you may have to pay $1,200 or $1,500, with the extra money going toward your eventual down payment.
- If the home’s value declines over the contract’s term, you are still obligated to purchase it at the higher price.
- If you decide to walk away from the arrangement, you’ll forfeit to the landlord all the additional money accrued.
- If you run across an unscrupulous landlord, he may take your money, not pay the mortgage, and lose the home to foreclosure, in which case you can find yourself out on the street. Or he could evict you on a flimsy pretext if he finds a more attractive buyer in the interim.
How to protect yourself
- Find out in advance which party pays property taxes, insurance, maintenance and repair costs, and any homeowners association fees.
- Get everything in writing, and have a real estate attorney review the contract before you sign anything.
- And treat the agreement as you would an actual home purchase: Have an appraisal and inspection done and run a title check to ensure the landlord actually owns the home and has no outstanding liens against it.
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