The rent-to-own type of transaction is far from a new concept – it first appeared in the United Kingdom and Europe and spread to the United States in the middle of the last century. The concept applies to goods like furniture or cars, but also housing.
Rent-to-own homes gained significant popularity during the ’80s and the ’90s, but with mortgages becoming considerably more attainable in the early 2000s they almost went out of fashion.
Today, in these changing times, many people have a hard time qualifying for a good credit score to purchase a new house, which has put this type of lease option in the spotlight again. Its popularity is growing, but it also comes with certain risks, mostly for the renter.
So to help you navigate this subject as safely as possible, today we’ll delve into the topic of rent-to-own homes and give you the rundown of the facts.
Rent-to-own-homes explained: why are they popular now
Nowadays, the relatively low interests for bank loans make receiving a credit from the bank seem very easy and cost-effective. But this only works for those with stable employment and income, which leaves us with millions of people who don’t make the cut and are struggling to solve their living situation.
Advantages of rent-to-own homes
After the great economic crisis, banks have increased their demands and inspections for potential credit receivers. As a result, people who go bankrupt, lose their jobs or experience other kinds of problems, may not be eligible for a good credit score, and thus have a decreased chance of homeownership.
In such a scenario, a rent-to-own agreement is a good potential alternative, as renters can live in a home for a certain period, with an option to buy it before the deal expires. This option can be a safety net mechanism, and may also increase the buyer’s likelihood of qualifying for a mortgage later on.
The landowners can also benefit from this agreement, especially for those hard-to-sell properties. This way they are meeting half-way with people who are having a hard time buying the property.
Are there risks to entering rent to own agreements?
With rental properties, the owner is obligated to maintain the property. More precisely, the property manager does this job. In rent-to-own agreements, the case is different, as, for property owners, there isn’t much interest in maintaining a property that will be sold at a later date, and won’t generate long-term profit. If the owner decides that the maintenance is up to the tenant, that should be clear from the beginning.
However, there have been situations with rent to own homes when this was not communicated well, and in such circumstances, there’s always the risk of the tenant ending up in a rundown home, similar to the story described in the Houston Chronicle.
Another downside to entering a rent to own agreement is that the rent in these agreements is usually a bit higher, especially if the portion of each payment is applied to the final price (will be explained later in the article). If the tenant doesn’t buy the property in the end, it’s on their loss.
In case the tenant changes their mind at the end of the contract the owner is left with the same potentially unattractive real-estate to put again on the market. This is one of the downsides for owners and property managers, as they will have to put this property back on the market.
How do rent-to-buy homes work
Now it’s time to look at the particularities of rent-to-buy homes – the contracts, fees, and prices over which the owner and the buyer should settle an agreement. We’ll also explore some of the more common issues that may emerge with this type of contract.
Types of agreements
There are two different types of contracts for rent-to-own properties. Some are more tenant-friendly, while others are more obliging. Due to risks that may emerge in both types of agreements, it’s recommended that both sides have legal support in the process.
The contract is a two-component one. It consists of the lease option, which is the standard part of the rental agreement, and the option to purchase.
This type of contract is more flexible for the tenant. It gives them the right, but not the obligation, to purchase the home after the lease contract expires. This arrangement is just like regular renting for the owner, and serves as a sort of test drive for the renter.
The lease-purchase agreement is more strict to the tenant. At the end of the contract, they simply have to purchase the home, whether they can afford it or not. This may complicate things in cases where the tenant doesn’t succeed in getting a mortgage, or collecting sufficient funds to pay for the home.
The usual practice with rent-to-own agreements is that the renter pays an initial one-time, non-refundable fee. This upfront fee gives the tenant the option of buying the house when the lease agreement expires. The fee usually ranges from 2.5% to 7% of the purchase price.
Purchase price and rent: gains and losses
Owner and buyer can settle the agreement over the purchase property price before signing the initial agreement, or after it expires. If the price is predetermined it will usually be higher than the property’s market value at the time of entering the agreement. If they wait for the lease to expire, it will be defined according to the value at that time.
In case the prices are trending up, the buyer will probably want to define the cost in advance. This may seem more expensive but is actually a safety net. If there’s no rising trend, then agreeing over the price at the end of the lease will not seem so risky. On the other hand, price predetermination in case of a rising trend in the real estate market might seem risky to the seller, as they may end up selling the property for a price significantly lower than its value when the agreement expires.
On top of this, there is another agreement to be made between the parties: whether the portion of each rent will apply to the later purchase price, or not. If it does apply, it might help the buyer earn some rent credit during the lease agreement period.
Rent-to-own homes are one of the options for people having a hard time getting a mortgage to buy a home or landowners and managers struggling to sell a certain property. If properly and honestly conducted, this way of doing business can be beneficial for both the tenant and the owner. However, to avoid potential disputes, it’s important to settle over the major issues like the rent price, purchase price, the application of rental portions to the final price, and maintenance responsibilities.