If you are like most home buyers, you are going to require a mortgage to finance buying a new property. To qualify, you should have a great credit score and money for a deposit. Without these, the standard route to homeownership might not be an option. (For more, see The Intricacies of Seller-Financed Real Estate Deals.)
There is an option, however: a rent-to-own arrangement, in which you lease a home for a specific period of time, with the option to buy it until the lease expires. Rent-to-own agreements consist of 2 components: a standard lease agreement and an option to buy. Here is a rundown of things to watch for and how the rent-to-own procedure functions. It is more complicated than leasing and you will have to take extra precautions to protect your interests. Doing this can help you discover if the deal is a fantastic choice if you’re looking to buy a home.
You Will Need to Pay Option Money The option fee is often negotiable, since there’s no standard speed. Nonetheless, the fee generally ranges between 2.5% and 7% of the purchase price.
It is important to be aware there are various sorts of rent-to-own contracts, with some being more user friendly and more flexible than others. Should you choose not to buy the property at the end of the lease, the option only expires, and you can walk away with no obligation to keep on paying rent or to buy. With these you might be legally obligated to buy the home at the end of the lease — if you can afford to or not. To possess the option to buy with no obligation, it ought to be a lease-option contract. Because legalese can be difficult to decipher, it is always a great idea to review the contract with a qualified real estate attorney before signing anything, so you understand your rights and precisely what you are getting into.
Establish the Purchase Price
Rent-to-own agreements must define when and how the home’s purchase price is set. Sometimes you and the seller will agree on a purchase price once the contract is signed — often at a higher cost than the current market value. In other situations the cost is determined when the lease expires, depending on the property’s then-current market value. Many buyers prefer to”lock in” the purchase price, particularly in markets where home prices are trending upward.
You will pay rent throughout the lease term. The question is whether a part of each payment is applied to the eventual purchase price. For instance, if you pay $1,200 in rent monthly for three decades, and 25 percent of this is credited toward the purchase, you will earn a $10,800 lease credit ($1,200 x 0.25 = $300; $300 x 36 months = $10,800). Normally, the rent is a bit higher than the going rate for the area, to compensate for the lease credit you receive.But make certain that you understand what you are getting for paying that premium.
Care: It May Not Be Like Renting
Based on the details of the contract, you could be responsible for maintaining the property and paying for repairs. Normally, this is the landlord’s duty so read the fine print of your contract carefully. Because sellers are ultimately responsible for any homeowner association fees, taxes and insurance (it is still their property, after all), they generally choose to pay these costs. In any event you’ll require a renter’s insurance policy to cover losses to personal property and provide liability coverage if someone is injured while at the home or in the event that you accidentally injure someone. (For more, see 6 Great Reasons For Renter’s Insurance.)
Be sure maintenance and repair requirements are clearly stated in the contract (ask your lawyer to explain your duties ). Keeping the property — e.g., mowing the lawn, raking the leaves and cleaning out the gutters — is quite different from replacing a damaged roof or bringing the electrical up to code. Whether you are going to be responsible for everything or just mowing the lawn, have the home inspected, arrange an appraisal and be sure that the property taxes are up to date prior to signing anything.
What happens when the contract finishes depends upon which sort of agreement you signed. For those who have a lease-option contract and want to buy the property, you’re probably going to have to find a mortgage (or alternative financing) so as to cover the vendor in full. Conversely, if you choose not to buy the home — or can’t secure funding by the end of the lease term — the option expires and you move from the home, just as if you were leasing any other property. You’ll probably forfeit any money paid up to there, including the option money and any lease credit earned, but you won’t be under any obligation to keep on leasing or to buy your home.
For those who get a lease-purchase contract, you might be legally obligated to buy the property once the lease expires. This may be problematic for a number of reasons, particularly if you are not able to secure a mortgage. Lease-option contracts are nearly always preferable to lease-purchase contracts because they provide more flexibility and you don’t risk getting sued if you’re unwilling or not able to buy the home if the lease expires.
Who is an Ideal Candidate for Rent-to-Own
A rent-to-own arrangement can be a great option if you’re an aspiring homeowner but are not quite ready, financially speaking. These agreements provide you the opportunity to receive your finances in order, improve your credit rating and help you save money for a down payment while”locking in” the home you want to get. If the option money or a proportion of the rent goes toward the purchase price — that they frequently do — you also get to build some equity.
While rent-to-own arrangements have traditionally been geared toward individuals who can not qualify for conforming loans, there is a second set of candidates that have been largely overlooked by the rent-to-own industry: people who can not get mortgages in expensive, nonconforming loan markets. “In high-cost urban real estate markets, where jumbo [nonconforming] loans are the norm, there’s a massive demand for a better alternative for financially viable, credit-worthy men and women who can not get or do not need a mortgage yet,” says , founder and CEO of Verbhouse, a San Francisco–based startup that is redefining the rent-to-own sector.
“As home prices rise and an increasing number of cities are priced from conforming loan limits and pushed to jumbo loans, the issue shifts from customers to the home finance industry,” says Scholtz. With strict automated underwriting guidelines and 20% to 40% down-payment requirements, even financially competent individuals may have difficulty obtaining financing in these markets.
“Anything unusual — in earnings, for instance — tosses good income earners into an’outlier’ standing because underwriters can not fit them neatly into a box,” says Scholtz. Including individuals who have nontraditional incomes, are self-employed or contract employees, or possess unestablished U.S. charge (e.g., foreign nationals) — and people who simply lack the tremendous 20% to 40 percent down payment banks demand for nonconforming loans. But all possible rent-to-own home buyers would benefit from attempting to write its consumer-centric attributes into rent-to-own contracts: The option fee and some of every lease payment buy down the purchase price dollar-for-dollar, the lease and purchase price are locked in for up to five decades, and participants can build equity and capture market appreciation, even if they choose not to buy. According to Scholtz, participants can”cash out” in the fair market value: Verbhouse sells the home and the participant retains the industry appreciation plus any equity they have accumulated through lease”buy-down” payments.
though you’ll lease before you buy, it is a fantastic idea to exercise the same due diligence as if you were buying the home .
If You Are Thinking about a rent-to-own home, be sure to:
- Choose the Proper terms. Enter a lease-option agreement as opposed to a lease-purchase agreement.
- Get Assist. Employ a qualified real estate attorney to describe the contract and help you understand your rights and duties. You might choose to negotiate some things before signing or prevent the deal if it is not positive enough to you.
- Be Sure to understand:The deadlines (what’s due when)
Who’s responsible for maintenance, homeowner association dues, property taxation and so on. Order an independent appraisal, obtain a property inspection, be certain that the property taxes are current and make sure there are no liens on the property. Check the vendor’s credit report to search for signs of financial trouble and get a title report to learn how long the vendor has owned it — the longer they have owned it and the more equity, the better. Under some contracts, you drop this right if you’re late on just 1 lease payment or if you don’t inform the vendor in writing of your intent to buy.
The Most Important Thing
A rent-to-own arrangement enables prospective home buyers to move into a home straight away, with several years to work on improving their credit ratings or saving to get a down payment prior to attempting to have a mortgage. Needless to say, certain terms and conditions have to be fulfilled, in accordance with the rent-to-own arrangement. Even if a real estate agent helps with the process, it is crucial to seek advice from a qualified real estate attorney who will explain the contract and your rights before you sign anything.