Should You Consider a Rent-to-Own Home to Get Into the Market?

Buying a home is super expensive, especially in certain markets across California. Many would-be buyers often find themselves priced out of the market because listing prices are far out of their financial reach.

But that doesn’t necessarily mean their dreams of homeownership are necessarily crushed. Rent-to-own home programs are designed specifically for buyers who might have a tough time purchasing a home the traditional way.

The question is, is a rent-to-own arrangement right for you?

How Does Rent-to-Own Work?

A rent-to-own arrangement involves two contracts: a rental agreement and an “option to purchase” or “lease option.”  The rental agreement is pretty similar to a conventional lease that specifies the address of the property, the amount of rent payable every month, when the rent is due, and the term of the lease. In the case of a rent-to-own rental agreement, terms are usually up to three years, compared to 12 months for traditional leases.

The option to purchase contract gives you the option to buy the home once the lease term is up. You will be given the first opportunity to buy the property before any other buyer is given the chance. But in order to stay first in line, an option fee will typically be charged. This fee can range quite a bit from one contract to another, though it is usually anywhere between 2% to 7% of the purchase price of the home.

However, this option fee is put towards the home’s purchase price, so you’d be getting that money back if you choose to buy. Having said that, if you decide not to go through with the purchase, you won’t get that money back.

It should be noted that you are not obligated to buy the home once the term is up. You are free to walk away if you so choose. If you do decide to buy the home, on the other hand, the purchase price will usually be an agreed-upon number at the beginning of the term and will be stipulated in the contract. 

A certain portion of the monthly rent will go towards rent to the landlord, while the remainder will go towards the purchase price of the home and therefore will be used to build equity. It’s important to understand exactly how the monthly rent will be split.

If the rent amount you pay is more than the going rate for rent for a similar property in your area according to a professional appraiser, any amount over that figure will go towards the down payment. So, if you’re paying $200 more than what current rent fees are in your area, it will go towards your down payment, further helping you to build equity.

What’s in it For Buyers?

Rent-to-own programs can be a great way to help buyers get into the market if they’re finding it hard to come up with the money needed to buy a home the conventional way. They’re also helpful for buyers who aren’t able to come up with a sizeable down payment or lack the credit score needed to secure a mortgage.

With a rent-to-own program, buyers will be able to build their credit back up by making regular rent payments while gradually building equity in the home. By the time the lease option contract is up, buyers will already have some amount of equity in the property.

Not only that, but it’s possible for the home to be worth more than what the initially agreed-upon purchase price is according to current market conditions. That allows you to potentially benefit from even more equity in the property.

These programs also provide buyers with the chance to test out the home and the area it’s located in before making the commitment to buying. When the term is up, you can then decide if you want to stick around for the long-haul or not.

What Are the Downsides?

As beneficial as rent-to-own programs can be for buyers, they can come with some risks, too.

For starters, buyers who have not used the time wisely to improve their credit and save up for a down payment may find themselves unable to get approved for a mortgage when all is said and done. If that happens, all the money that was put into the home will be lost. To help prevent this scenario, it’s highly recommended to work with a mortgage specialist before entering this type of contract to find out what’s required to be eligible for a mortgage when the lease term expires.

And while there is a good chance that the home may be worth more when the lease term is up compared to what was agreed upon at the onset of the contract, there’s also a chance that the home may be worth less. If that’s the case, you may wind up having to pay more for the property than what it’s actually worth (assuming you agree to go ahead with the option to purchase).

If you choose not to exercise your option to purchase, you’ll lose any monies they put towards the arrangement, including the rent to the landlord and lease option fees.

The Bottom Line

If you’re looking to buy a home but aren’t qualified to get approved for a mortgage to purchase a property the traditional way, a rent-to-own program may be a great option to consider. That said, it’s important to assess your situation and be realistic about your ability and willingness to save money, make payments on time, and boost your credit.

You should also work with a real estate agent to make sure that the purchase price stipulated in the contract is fair. You might also want to consider other mortgage options to see if you’d be able to qualify for another type of home loan. Either way, be sure to team up with a panel of experts to help you make the right decision for you.