For many, buying a home remains the American dream. Traditionally, buying a home entails getting approved for a mortgage and purchasing the home outright. There are, however, other options such as the rent-to-own route. Whether you are a seller or a buyer, understanding the rent-to-own process can help you decide whether it is a viable option for you.
From a buyer’s standpoint, the rent-to-own option, also referred to as a “lease option contract”, may be an attractive option if the buyer cannot obtain conventional financing right away because of a poor credit score or an insufficient employment history. A buyer may also choose to enter into a lease option contract if the buyer is new to the area and not certain where he or she wishes to live. From a seller’s point of view, a rent-to-own agreement offers an option when the market is slow and a house has been on the market for some time without selling.
Although the exact terms of a rent-to-own agreement or lease options contract may vary, the basics remain the same. A renter enters into an agreement to rent the property for a specific term just as in a conventional lease agreement; however, the renter also pays an additional sum of money for the option to purchase the property at a fixed price within a specific time frame. This offers the buyer the time necessary to qualify for conventional financing. The funds paid for the option are usually non-refundable, meaning that if the renter does not ultimately purchase the home the money is lost.
Typically, the funds are credited to the purchase price if the sale does goes through. In addition, a percentage of the monthly rent payments may also be credited to the purchase price of the property.
For example, imagine that a home is listed for sale for $150,000 but you, as the purchaser, are unable to obtain conventional financing right now. You are, however, relatively certain that if you are able to work on your credit score over the next two years that you will be approved for a mortgage. You and seller could enter into a rent-to-buy contract that allows you to rent the home for two years with an option to purchase the home for the $150,000 price if you can accomplish the sale within the two year period. In the meantime, you will pay monthly rent in the amount of $900. You will also pay an option fee of $2,500 which locks in the purchase price for the next two years. If you ultimately purchase the home, the $2,500 will be applied to your down payment; however, if you do not purchase the home, the seller gets to keep the $2,500. You may also be able to get the seller to agree to apply some of the monthly rent payment toward your down payment if you buy the home.
As the buyer, you get extra time to work on any issues that need to be resolved in order to qualify for a mortgage. You also know that the money you paid for the option to purchase as well as some of your monthly rent is going toward a down payment which makes saving for the down payment easier. The seller, in turn, covers his or her monthly mortgage payment and knows that one of two things will happen within the time frame agreed upon in the contract – either home will be sold or the seller will be able to keep the option fee funds as compensation for having kept the home available for the buyer.