Most home buyers go the traditional route of securing a mortgage loan to buy a house. Of course, getting approved for that loan generally requires a significant amount of cash and a relatively good credit score of around 685 or higher. Without that, you may be looking at other alternatives such as rent to own real estate agreements.
This option, once primarily run by small outfits and individual sellers, was especially popular in the 1990s, when there were many consumers strapped for cash, but a decade later were practically unheard of due to the easy lending options that made it possible for just about anyone to purchase a home with no down payment whatsoever.
In more recent years, with the much stricter standards set by lenders, rent-to-own has become more common once again, as the Wall Street Journal notes. The agreement requires renting a home for a set period of time, perhaps three to five years, with the option to buy before the expiration of the lease.
It’s a bit more complicated than renting a home, but knowing just how it works can help you better determine if it’s the right choice for you.
Rent-To-Own Work
Upfront Costs
While you won’t have to cough up 20% for a down payment, you will need to pay some costs upfront. Known as “option money,” this provides the option to buy at a later date.
There’s usually room for negotiation as there isn’t a standard rate, but it typically ranges anywhere from 2.5% to 7% of the total price that’s agreed upon.
If you were to take on a rent-to-own home for $200,000 and paid a 4% option fee, you’d pay $8,000 up front. It’s a good idea to have that money go toward purchasing at closing time, so you’ll want to ensure that’s included as a clause in the contract.
The Purchase Price
The agreement will need to specify how and when the purchase price of the home is figured out, as market values can change significantly even over a relatively short period of time.
In some situations, that may occur when the lease expires, with the price determined on current market values at the time.
In others, you and the seller will agree on the price at the time the contract is signed – this is usually the better option, particularly in areas where prices are rising.
Of course, sellers who are looking out for their own interests will likely want to wait until the lease term is up to name a selling price of the house. Doing it this way takes into account not only fluctuating housing prices based on the market, but also any improvements the owner makes to the property during the time you are renting it.
Conversely, if housing prices are falling in your area, the seller would probably do well to name the price in writing now, before he or she gets too little for the property. You as the renter, however, can try to work with the seller on a fair price based on what you are each looking for.
Rent Applied to the Principal
You’ll be paying monthly rent throughout the term of the lease, but you and the seller will need to come to an agreement as to how much if any of those payments are applied to the potential future purchase.
For example, if the monthly rent is $1,500 and you pay that for three years with 25% of that amount credited toward the eventual purchase, you’ll earn a $13,500 rent credit ($1500 x 25% = $375 X 36 months).
Maintenance and Repairs
Typically, the homeowner will cover any maintenance and repairs while you’re still renting, though some contracts may state that you’ll have to pay those costs and perhaps other fees too.
Be sure the contract clearly spells out who will cover what because you could get stuck having to fix a major problem on a home that isn’t even legally yours.
Generally, a landlord will expect a renter to fix minor problems that arise over the course of a rental agreement. If you as the renter can quickly and easily fix a leaky faucet or tighten a door hinge, you may not need to have the landlord call in some expensive professionals.
If a storm blows through and rips some shingles off the roof, however, you will likely need the landlord to call a roofer, as fixing the roof is not within the realm of most people’s skills.
Author: Eric Adamczyk
