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As a tenant, you may have dreams of owning a property one day and building equity, not just paying rent.
But even though you’re a responsible tenant, you can’t afford a house at the moment.
Maybe you have a poor credit history.
Maybe you don’t have enough savings for a down payment.
Maybe you have too much debt.
Either way, we have good news to share: there is one option that allows tenants to make payments on a property while living in it — and this option eventually provides the tenant ownership of that property.
Sounds too good to be true?
It’s called rent to own.
The rent to own contract can also be advantageous for landlords who are looking to eventually sell a rental property.
In this article, we’ll break down what a rent to own contract looks like to help you decide if it’s right for you, whether you are a tenant seeking a permanent residence or a landlord looking to sell a property.
What is Rent To Own?
A rent to own contract is an agreement between landlord and tenant where the tenant has the option of buying the property before the lease ends.
The tenant pays a monthly rent and an extra amount each month that is set aside to go toward a downpayment.
Typically, the extra amount accumulates to 3.5% of the sales price, which is the minimum down-payment required by an FHA mortgage loan.
Landlords receive monthly income on the property during the lease period, with a guaranteed sale at the end.
Tenants are assured that a portion of their monthly rent will go toward a down payment on the property and they can enjoy living in the space before they own it.
How does rent to own work differently than traditional mortgage financing?
The biggest difference is that ownership is not transferred automatically from seller to buyer.
This happens after the specified amount of lease time on the contract.
Additionally, rent payments that are made during the lease period may not go toward building equity in the property or pay down a loan balance.
Advantages & Disadvantages of Rent to Own
Like many other aspects of real estate, there are advantages and disadvantages with entering into a rent to own contract.
- Tenants can live in the home they want to own before they are ready to secure mortgage financing
- During the lease portion of the contract, tenants are not liable for maintenance and repairs of the property
- For buyers, a great advantage is securing a sales price at the time of the contract signing that is locked in irrespective of how housing values increase
- Landlords will receive monthly profits during the lease period with a guaranteed sale at the end of the lease
- Landlords have nothing to lose with the option fee that is paid at the beginning on the rent to own contract
- Rent to own can be costly with the upfront option premium required on the lease
- Money set aside during the rent period is not refundable if the tenant changes his or her mind about buying the property
- Rent to own contracts are written in the best interests of the seller, so buyers may be apprehensive and need to do their research before signing a contract
- For the seller/landlord, sometimes tenants that cannot qualify for a mortgage may be financially unreliable and also may not be qualified at the end of the lease period
The Rent To Own Process: 5 Steps
The rent to own process is different from your traditional home buying process — here’s what to expect along the way.
Step 1: Find a Property or Find a Tenant
For tenants, the first step is to find a property owner that would be willing to enter into a rent to own agreement — and a property that checks their boxes as well.
For landlords, the first step is to find an interested tenant.
Then, the respective parties should research the other party to make sure they are credible to enter into an agreement with.
Step 2: Draft a Contract
Next, a rent to own contract is drafted.
In this contract, both parties agree on the terms of:
- purchase price
- lease period
- option fee
- property maintenance roles of both buyer and seller
- and more
In this step, we recommend consulting with a real estate agent or real estate attorney to ensure legality.
Step 3: Lease Period Begins
The tenant begins paying rent every month, with a portion of the rent being saved toward the eventual downpayment for a mortgage loan.
Keep in mind that depending on the contract, the other portion of the rent may or may not go toward the original sales price of the property.
Step 4: Mortgage Financing Secured
Toward the end of the lease period, the tenant secures mortgage financing in preparation to buy the property.
Step 5: Property is Purchased
Finally, the property is formally purchased by the tenant and the rent to own contract is completed.
The tenant is now the owner of the home and the landlord no longer has any ownership interest.
How To Find Rent to Own Homes
How can tenants find rent to own homes in their local area?
Here are a few options.
Option #1: Inquire with Current Landlord
If tenants are happily renting a home and the landlord announces that they want to sell the property, they can ask to enter into a rent to own agreement.
Tenants can also ask their landlord if they’d be interested in selling the home to them down the line and draft a rent to own agreement.
Option #2: Homes That Have Been On Market for Some Time
Look online for homes that have been listed on the market for a long time without selling.
Then, approach the seller and see if they’d be willing to consider a rent to own contract.
Option #3: Inquire with Property Management Companies
Contact local property management companies to see if any of the homeowners are interested in doing a rent to own contract.
Option #4: Search Rent To Own Homes Online
Utilize websites that specialize in rent to own deals, such as HomeFinder.com, to see what rent to own properties they have available.
Rent to Own Red Flags
As with any major financial decision, there are some risks involved with rent to own agreements, whether you are a tenant or a landlord.
Here are some red flags to look out for on both sides of the deal.
- Fees that are exorbitant beyond the standard rent to own lease/contract
- A lease that stipulates high-interest rate financing
- A landlord that has a reputation for being predatory. Ask for references to vet potential landlords
- A home that is in disrepair, or a landlord that discourages you from getting an inspection or appraisal done
- (For landlords) A buyer that has a history of late payments within rental agreements and other financial obligations
- The landlord is not listed as the owner on the title report, or there are other judgements/liens placed on the property
The Bottom Line: Rent To Own
Rent to own is one strategy that can make homeownership more attainable for those who cannot save up a significant down payment while renting. It can also be advantageous for a landlord looking to eventually sell a property.
If you decide that a rent to own contract is what you’re looking for, ensure that you draft a contract and go through the process legally so that it’s a win-win for both parties involved.