What you need to know
You may have heard about doing a rent-to-own on furniture, appliances or electronics, but did you know it applies to homes too? It’s not common, though it’s still around, so it’s important to be well informed before you enter into any type of Rent-to-Own Agreement.
As a mortgage professional, we often don’t come into the rent-to-own transaction until the buyer is actually ready to purchase the house they have been renting-to-own. A big difference between a rent-to-own contract and a regular purchase contract is the purchase price was most often agreed upon when you originally entered into the rental agreement and the downpayment has been accumulating in someone else’s account. This downpayment amount is over and above the “market” rent you have been paying to live in that home. This option is ideal for investors as a revenue property strategy and for buyers who are unable to qualify for a mortgage right away. There are risks that accompany a rent-to-own contract for both the seller and the buyer and we suggest you continue reading for what you need to know about rent-to-own contracts from a mortgage professionals’ perspective.
Let’s start with the basics;
What is a rent-to-own contract and how does it work? A rent-to-own contract or sometimes called an ‘agreement-to-purchase’ is where renters pay market rent each month to live in a specific property and at the end of a set period, usually 1-3 years, they have the option to buy that property. The buyer and the seller/owner usually agree on a purchase price at the time they write the original rental/purchase agreement. This means the purchase price is set 1-3 years prior to when you actually have to qualify for a mortgage to purchase that property. If this is your first real estate transaction, I strongly suggest you have a lawyer review the purchase/rental contract before you sign it so you understand all of the potential ramifications.
In addition to the monthly rent to be paid, the seller/owner may collect an extra amount with each payment to go towards your downpayment when you “close” on the property. The seller/owner may also request an initial deposit at the time you enter into the rent-to-own contract. Make sure to inquire if either your initial deposit or the monthly amount going towards downpayment is refundable in the event you don’t proceed with the purchase at the end of the contract term for any reason. If you are unfamiliar with some of the terms used in the contract, contact a professional for guidance, whether it is a realtor, lawyer or a mortgage broker. Always be sure you know exactly what you are agreeing to when you enter into a rent-to-own contract.
Advantages of a rent-to-own agreement:
- If you’re a buyer who can’t qualify for a mortgage right now, Rent-to-own allows you to move into the house now and buy later. This gives you time to fix your credit, accumulate your downpayment or do whatever else you need to do in order to qualify for a mortgage.
- If you are a seller who can’t sell your property quick enough a rent-to-own contract could eliminate having 2 mortgage payments. Your renters will be covering your monthly mortgage payment on the property and you know how much you will sell your property for at the end of the rent-to-own term.
Disadvantages of a rent-to-own agreement:
- The purchase price is set at the beginning of the term, even if other housing prices rise or fall during that contract period as the original agreed-upon sale price is usually final.
- All of those repairs that used to be somebody else’s problem in a rented property often become the responsibility of the new buyer, even during the rental period. Ensure you have budgeted for home repairs.
- Some rent-to-own contracts are not suitable to a mortgage lender. The agreement must clearly outline the purchase price, initial deposit amount, monthly rental amount and additional amount going towards the downpayment. And again, it must specify whether or not any of those amounts are refundable should the contract not be honored for one reason or another. I encourage you to do a lot of research on this topic before you commit as I have seen these go wrong before and anything you can do to prevent that is a step in the right direction.
- Know and understand what you are getting into before signing! Make sure the seller is educated on the process both of you need to follow in order for you to eventually qualify for a mortgage at the end of the contract period. Again, we do suggest you contact a mortgage professional that knows exactly what is required by both the lender and the mortgage insurance companies.
- Make sure the purchase price you are agreeing to will be in your price range when it comes time to close and check around to ensure you are paying fair market value for the property.
- Ensure the rental amount you will be paying, not including the extra towards the downpayment credit, is reasonable for the type, condition and location of the property.
- Talk to a mortgage professional prior to selecting a contract term to ensure you can qualify for a mortgage amount sufficient to purchase that home when the contract is due.
Buyer or seller, if you’re thinking of using a Rent-to-Own as an effective real estate solution, it is not a bad idea to align yourself with a trusted experienced mortgage professional. They can help the sellers/owners pre-qualify potential buyers to make sure the contract terms are suited to the buyers borrowing abilities. They can also benefit buyers by guiding them on what they need to do to ensure they can qualify for a mortgage when it comes time to buy the property.