Are Rent-to-Own Homes Worth it?

If you’re in the market for a home and prices are abnormally high, this makes it much more challenging to save up for a significant down payment—let alone get approved for a mortgage.

If faced with these circumstances, you may consider exploring less traditional routes to homeownership. One popular option that often gains traction in these economic environments is rent-to-own programs. Here’s what you need to know about them.

How rent-to-own works

In its simplest form, a rent-to-own program is a lot like leasing a car: giving you the chance to “test-drive” a home for a specific period of time (months, years, etc.). Then, once the lease is up, you have the option to buy.

There are two different types of rent-to-own contracts. In a lease-purchase agreement, the price at which you buy the home is “locked-in” (as it’s preestablished at the start of the contract). Should you choose to buy as part of a lease-option agreement, you’ll negotiate a purchase price with the seller after your lease expires.  

While state laws vary regarding rent-to-own contracts, deals are often established per terms mutually agreed upon by the buyer and seller.

Advantages of a rent-to-own home (for the buyer)

In many cases, your monthly lease payment includes a premium applied towards the eventual purchase price of the home. As a result, you can build equity in the home, which is beneficial for several reasons. For starters, it means you’ll need to come up with only a modest down payment should you decide to eventually purchase the home.  Building equity may also make it easier for you to get approved for a mortgage once your lease expires. These advantages are appealing to many, especially those who can’t afford to buy a home because they are bogged down by too much debt, have shaky credit (a rent-to-own contract provides the opportunity to repair their credit over time), or lack the money needed for a down payment.

Another benefit for buyers is that at the conclusion of the rent-to-own agreement, they can avoid competition from other buyers because these contracts often give renters exclusive rights to purchase the home.

As mentioned earlier, rent-to-own lease-purchase agreements allow you to lock in a purchase price early on. This can make for a profitable situation if you find yourself in a hot real estate market with increasing home prices at the end of your lease.

Finally, the ability to experience life in a home before you buy is often very appealing as it gives you time to familiarize yourself with the neighborhood and surrounding areas. If you ultimately decide to walk away at the end of your contract, this is easy to do since there is no legal obligation to buy the home.

Disadvantages of a rent-to-own home (for the buyer)

Rent-to-own home programs also have several drawbacks. For starters, rent is more expensive than in a traditional lease—especially if a portion of the payment is applied toward the equity in the home. Many experts agree that it’s better to save that money on your own, especially when you consider all the risks involved with rent-to-own contracts.

A second shortcoming is that buyers may ultimately need to pay more than the home is worth— should they decide to buy—if they find themselves in a down market with significantly depreciated home values when the lease expires. There is certainly no way to know in advance what the real estate market will look like at the end of a lease; consequently, locked-in prices may not seem so appealing anymore.

Another potential issue with rent-to-own contracts is when you decide not to buy. Perhaps you still can’t qualify for a mortgage or need to relocate for work. Regardless of the reason, you’ll likely forfeit the money you paid to your landlord: including any additional premiums that went towards the purchase price of the home.

Your sunk costs are often even more damaging if you pay an option fee: a one-time fee that is usually non-refundable but gives you the option to buy the home in the future. While negotiable, this is often 1%-5% of the purchase price of the home.

Depending on how the contract is structured, you may be required to maintain the property and pay for repairs. If this is the case and you fail to do so in a timely manner, you may forfeit your right to buy the property because sellers often include a clause in the contract stipulating this. It’s therefore important to ensure maintenance and repair requirements are clearly outlined in your agreement.

A final negative associated with rent-to-own contracts is that the deed isn’t under the renter’s name. Therefore, he or she has no real authority over property affairs, and in the event of a foreclosure, the home goes to the bank instead.

Other details to know about rent-to-own homes

There are multiple ways to find rent-to-own homes, such as working with a real estate agent or visiting specific websites (renttoownlabs.com comes to mind).

It’s important to know that rent-to-own scams are also very common. For example, many renters learn after the fact that the “seller” doesn’t own the property, the owner is behind on property taxes, or the home is afflicted by mold, lead, or asbestos. Therefore, it pays to properly research the home, obtain an inspection, and ensure there are no liens on the property. You should also research the seller by checking his or her credit report and obtaining a title report to learn how long the seller has owned the property. A real estate attorney can help ensure you’re getting a fair deal.

The bottom line on rent-to-own homes

Rent-to-own homes may make sense for some, especially first-time homebuyers not quite ready to obtain a mortgage. Though these properties are sometimes profitable in a rising housing market (assuming you have a locked-in purchase price), we generally believe rent-to-own agreements come with far too many risks that outweigh any potential benefits. Consequently, we recommend avoiding rent-to-own agreements if at all possible.

———

Vision Retirement is an independent registered advisor (RIA) firm headquartered in Ridgewood, New Jersey. Launched in 2006 to better help people prepare for retirement and feel more confident in their decision-making, our firm’s mission is to provide clients with clarity and guidance so they can enjoy a comfortable and stress-free retirement. To schedule a no-obligation consultation with one of our financial advisors, please click here.

Disclosures:
This document is a summary only and is not intended to provide specific advice or recommendations for any individual or business.