Many first time homeowners are increasingly finding it difficult to save for down payments to purchase their own homes. And if they do tuck enough money away, they may face other challenges like poor credit scores. All these hurdles may make the dream of owning a home further and further out of reach.
More and more home buyers are now looking to rent-to-own agreements in an effort to get on the path toward homeownership without fully committing. But are these agreements a good thing for home buyers? What are its benefits? And what could they end up costing buyers?
Here’s our comprehensive guide to rent-to-own agreements and the free listings you’ve probably come across on your home buying journey.
What is Rent-to-Own?
Simply put, a rent-to-own agreement allows you to rent a home for a specified amount of time with the option to buy before or when the contract expires. Basically, it gives the buyer the option to purchase a home he or she is renting at some point in the future.
Under the agreement, the buyer and seller agree to the potential that the property will be sold to the renter at some point in the future. The option to buy is up to the renter. The rental payments or part of the total rent paid can be used to pay partially or substantially for the ultimate down payment to the seller (should the sale go forward).
This option can be attractive for buyers who think they will be in a stronger financial position in the future. For example, they may have bad credit and so cannot qualify for a home loan. They could use the time of the rent-to-own agreement to raising their credit scores so they can be approved for a mortgage.
Another advantage for the buyer: These agreements give you the chance of seeing if the home is right for you, without committing to the purchase. This can be beneficial if you are not sure about the neighborhood where the home is located and it can also let you give you firsthand knowledge of any problems the home may have before you buy it.
What Is “Option Money” in a Lease-Option Agreement
In a lease-option agreement, the potential buyer will usually have to give a non-refundable payment at the beginning of the contract term. This is known as “option money” and is a small percentage of the total purchase price of the home.
If you buy the home, the option money is what goes toward the final purchase price. If the buyer decides not to buy the home, the “option money” is forfeited.
A lease-purchase agreement does not involve option money. But it establishes the date of purchase for the rent-to-own property and it can also set the purchase price, which can be determined at the signing of the initial contract or based on a home appraisal in the future.
How Do They Work?
The buyer and seller negotiate the terms of a rent-to-own agreement, and almost everything is negotiable. So, it’s in the buyer’s best interest to work with a professional agent before signing any lease-option agreement. A trusted Clever Partner Agent can help you avoid any risks associated with rent-to-buy agreements.
Rent-to-own transactions require that the buyer pays an option premium at the beginning of the contract period. It can be around 5% of the final purchase price. Sometimes it’s lower, though it can also be higher than that. It’s this payment that allows the buyer the option of buying the home in the future, but it does not obligate the renter to complete the purchase.
There is a cost for the buyer, however, and that’s the forfeiture of the option premium or option money. In other words, there are “no refunds.” But there is a big plus for buyers, the money can be applied to the purchase price if the purchase is completed.
Pros of Rent-to-Own Agreements
There are several pros for buyers when it comes to rent-to-own listings. For one thing, it can make the process of buying a home simpler and easier if a buyer does not have enough for a mortgage or down payment.
It can also allow you to purchase the home at the current market price. This is a big advantage for those people in a hot real estate market who are watching home prices climb and climb.
In some communities, a home can go up by tens-of-thousands of dollars in a single year. Waiting just a few years to buy can be costly and it could even put your dream of buying a home out of reach. Rent-to-own agreements can be a useful option for people who are worried they’ll be priced out of the market.
What are the Risks of Rent-to-Own Agreements?
Rent-to-own agreements present quite a few drawbacks for home buyers, as well. Real estate lawyers warn there are many shady operators willing to take advantage of people who are having a financially difficult time and are hoping to buy a home through rent-to-own.
They also warn, there are not many legal remedies, should problems arise with the homeowner before the purchase is complete. The possibility that you will lose your initial option money is real, and you will want to discuss all facets of these agreements with a partner agent.
It’s important to determine and set out beforehand what the buyer’s responsibilities are and the responsibilities of the seller. For example, many rent-to-own agreements make repairs and maintenance the responsibility of the renter or potential buyer.
Also, if you choose the rent-to-own option because of a poor credit score or current financial difficulties, you will want to ensure you are in better financial health in the future. If you do not have a plan or there does not seem to be a realistic possibility that your credit score or financial position will improve, you may not qualify for a mortgage. That means you could just end up losing the option money you put up initially.
If you work with a trusted real estate agent you will get the advice you need to make sure you do not lose your hard earned money. Clever Partner Agents can work with you and guide you to options to buy that you may not have considered. They can also steer you to many government loan and mortgage programs that are designed for low-income home buyers and people with low credit scores.