The Basics of Rent-to-Own
In a rent-to-own arrangement, you lease the property for a specific time period. During or at the end of the lease term, you may exercise the option to buy the property for a specific price. Usually, you and the landlord negotiate the price and other terms of the option before the lease term starts.
The agreement shares many of the hallmarks of a typical lease. As a tenant, you pay monthly rent or face eviction. The lease agreement may restrict the presence of pets (subject to federal or state disability laws), use of the property and your ability to alter the property or remove items from it.
With the option to purchase come departures from a regular lease agreement. The landlord devotes a portion of the rent to the purchase price. For that reason, expect to pay more in a rent-to-own lease than a traditional lease. Since you and the landlord contemplate that you will own the property by the end of the lease, the landlord may assign to you the responsibility for maintenance and repair of the air conditioning and other utilities in the home. In traditional leases, the landlord would be responsible for such items.
Why Rent-to-Own?
Cannot Qualify for Mortgage?
As with owner financing in general, a rent-to-own arrangement takes the bank or mortgage company out of the mix — at least initially. By dealing with the seller, you do not have to satisfy underwriting standards that form barriers to mortgages and home ownership.
Credit Scores. At a minimum, you need a credit score of 620 to qualify for a conventional mortgage. For home loans backed by the Federal Housing Administration, the floor sits at 580. If you have a down payment of ten percent, scores between 500 and 579 might qualify you for an FHA loan. Bear in mind that many lenders have higher minimum credit scores.
If you have a sub-par credit history and score, you likely will not qualify for a loan without rebuilding on-time payment history and lowering your debt load. A rent-to-own approach gives you that time to improve your scores.
Down Payment. The upfront cost for a rent-to-own consists of a relatively-small option fee. Contrast that with a bank or mortgage company’s demand that you front 20 percent of the purchase price. For a home with a $200,000 price tag, that translates to a $4,000 loan. If you cannot put down 20 percent, the lender will require of you private mortgage insurance (PMI) that covers the lenders’ losses should you default on the loan. With rent to own, you might face a lump-sum payment and the need for a mortgage. That comes, though, on the back end rather than the front.
Not Quite Ready to Commit to the Property?
The option component of a rent-to-own contract allows you to weigh many factors and consider other options for a home. With no obligation to buy, problems with the foundation, walls, ceilings, roof and other parts of the home do not have to become your headaches. By contrast, in a traditional sale where you have a mortgage, you face a more difficult path in rescinding the deal or being compensated for having to fix the problems. In such a transaction, you must show some fraud or knowledge by the seller.
A Hedge Against Market Changes
By entering into a rent-to-own or other seller-financing arrangement, you have an established price now that you have to pay in the future. Should home prices across the market rise, your price (whether through a traditional contract or option) can prove to be a bargain. If prices of comparable properties or in the market fall, you can search for those lower-priced properties.
The Land Contract
An installment land contract accomplishes many of the purposes of rent to own transactions. As a form of seller financing, a land contract normally does not come with the credit and other standards to qualify. You get to immediately assume possession upon signing the contract. However, the owner retains title to the property until you have paid the purchase price. As you make payments, the balance (i.e. the price) decreases, and your equity grows.
Pay attention to whether the contract contains a forfeiture clause. This provision allows the seller to avoid paying you the equity you have built should you default on a payment. To that end, your ability to make payments should weigh heavily in your decision to enter into an installment land contract — even if the seller does act as a loan underwriter.