Wouldn’t it be nice if, instead of paying rent on one home while saving for another, you could put all of your housing budget toward one place, essentially building equity through rent payments? This is possible through rent-to-own programs. But if you think it sounds too good to be true, you might be right.
What is rent-to-own?
A rent-to-own home agreement means you rent a home for a certain period of time with the opportunity to buy it at the end of the lease. As you pay rent, the seller sets aside a portion of that cash toward your equity in the home — essentially building up your down payment over time.
As a buyer, it’s critical to understand the two types of rent-to-own agreements.
- Lease option: This gives you the ability to buy at the end of your lease period, but you aren’t obligated to.
- Lease purchase: This contractually requires you to buy the home at the end of your lease — even if you can’t necessarily afford it.
Understanding How Rent-to-Own Homes Work
While not all rent-to-own agreements are exactly the same, most have similar features:
A one-time payment you make upfront to the seller that gives you the option to buy the home in the future. This is usually 1% to 5% of the home’s purchase price and is non-refundable — even if you don’t decide to buy the home.
Rent-to-own contracts specify when and how the purchase price will be decided. This could be when the contract is originally drawn up (potentially years before your lease ends) or determined at the end of the lease.
Sellers often prefer locking in the purchase price based on its predicted future value at the time of signing the contract — especially in areas where home values are rising. If prices fall during the leasing period, you’re still required to pay the agreed-upon amount, which could be more than the property is worth.
The monthly cost includes a credit toward your home (aka your down payment), so you’ll likely pay a higher rent than what’s typical in the area.
Oftentimes, buyers must handle regular upkeep that landlords typically cover, like lawn care. You might also be on the hook for more serious fixes including appliance repairs. Closely read your contract to fully understand what costs you’re responsible for during your lease.
Because rent-to-own contracts can be tricky, it’s important to work with a real estate attorney to thoroughly review the terms and timelines so that you understand what you’re responsible for.
Rent-to-Own Home Considerations
If you don’t have the money for a down payment or the credit score you need to qualify for a mortgage, or have a high debt-to-income ratio, rent-to-own programs can provide an alternative route to homeownership. But it’s important to weigh their benefits and drawbacks as you consider if you’re ready to buy a house.
|Buyer benefits||Buyer beware|
|Won’t need a substantial down payment||Pay more in rent|
|Have built up equity||Could be locked into an over-valued home price|
|Secure a home before you’re ready for a mortgage||Committed to buying but aren’t ready to|
|Lower barrier to entry of homeownership||Maintenance and repair costs|
|Lost money if you decide not to buy|
|Potentially sued if you break lease purchase contract|
Sellers also face positives and negatives in a rent-to-own situation. It’s a good idea to know where they are coming from.
|Seller perks||Seller setbacks|
|Earn rental income||Renter may choose not to buy|
|Could sell home for more than it’s worth||Prices may go higher after locked into contract|
|Don’t have to perform traditional landlord duties|
|Contracts tend to favor seller|
Alternatives to Rent-to-Own Agreements
If the thought of a 20% down payment has you considering a rent-to-own agreement — know that you have other options, like these two alternatives:
Wait and Save
It’s perfectly acceptable to rent a property as you save for a down payment, build credit, or get your finances in line. In fact, waiting a little longer so you can buy a home when you’re financially stronger will likely only benefit you in the long run. Plus, when you take out a traditional mortgage, like those offered by Ally Home, you can avoid confusing contracts and getting locked into an agreement you may not want to keep.
Special Loan Programs for Homebuyers
While a 20% down payment may be the industry standard, it’s by no means a requirement. Several programs exist to help you buy a home with a down payment as low as 3%. Be sure to check with lenders like Ally Home to see if you qualify for Fannie Mae’s HomeReady program, or an FHA loan as you review different options.
It’s all in the contract
Rent-to-own homes can help you out as a first-time homebuyer. But to protect yourself, you must do your due diligence. Take time to research the home and seller and enlist professional help when and where it’s beneficial. Because when it comes to your finances and future home, no detail is too small.
Ally Home provides various mortgage options to best suit your needs.