There are no hard and fast rules with rent to own.
Unlike traditional real estate transactions, rent to own arrangements are more personalized and flexible. This can be a good thing or a bad thing. It can be a good thing when you make an arrangement with the seller that is fair and beneficial to you.
It can be a bad thing if you do not pay attention to the contract you sign—because you can quickly get yourself into a deal with unfavorable terms where you see little to no benefit, and the seller sees all the positives.
You will need to negotiate a contract.
All real estate transactions involve contracts and rent to own is no exception. You need to do your homework to make sure you understand what should be included in the contract and what the terms should look like.
You are negotiating a business deal, so you need to be careful. It is an excellent idea to hire a real estate attorney to look over the contract and explain it to you, so you avoid entering a deal that you do not understand.
Know your contract terms and how they will affect you.
- Lease term. The lease term defines how long the lease will last before you will need to buy the home or move out. You and the seller can agree to any lease term you like. Most rent to own lease terms range from one to three years. Be realistic about how long it may take you to get ready to buy—including repairing your credit and saving up for a down payment. A one-year lease term may not be long enough for you to get your finances in order.
- Option fee. This is the fee you are going to pay the seller for the option to buy the home. The option fee is usually something you can negotiate. Typically, the cost will range between 2 percent and 7 percent of the purchase price of the home, although it can be lower or higher depending on your individual circumstances. Sometimes the option fee can be applied to the purchase price of the house, again depending on what you negotiate with the seller.
- Lease option or lease purchase. You have two different options when it comes to a rent to own agreement—a lease option or a lease purchase. You want to be confident what your contract says here because there is a big difference between the two. A lease option means you will have the right to purchase the home at the end of the lease. You can buy or not buy. A lease purchase agreement means you are legally obligated to buy the house at the end of the lease. If you do not have the financial means to buy the home or do not want to buy the home at the end of the lease, a lease-purchase agreement will put you in a challenging position.
- Rent credit. In a rent to own agreement, it is standard for some portion of your rent to go towards the down payment on the home. Usually, the rent credit ranges between 10 percent and 25 percent, but again, it all depends on what you negotiate with the seller. There are no hard and fast rules for the rent credit. You should insist that the rent credit is kept in an escrow account to protect you and the seller.
- Purchase price. Some rent to own agreements establishes the purchase price when the contract is written at the beginning of the lease. Other contracts state that the fair market value will be determined at the time of purchase. Either way, you want the decision on the purchase price in the agreement.
- Maintenance. You can negotiate who is responsible for the property maintenance, both everyday maintenance like mowing the lawn, and significant maintenance like replacement of the roof, or the HVAC system. Major maintenance is expensive, so be careful about what you agree to. Either way, you should get a home inspection before signing the agreement.
- KNOWN EXPERIENCES! I had a client call me because he had added an entire new HVAC system including the duct work! The seller at the end of the lease purchase agreement, updated the value to the purchase price to the current day condition and market price! $30,000 more than the buyer had agreed upon in the original contract! “Who is RIGHT?” “GET IT IN WRITING!”
There are several terms of the contract that you will need to pay close attention to. These include:
Leasing to Own: Pros and Cons For Buyers and Sellers
In the majority of leasing to own situations, the bulk of the advantages are on the homeowner’s side. However, there are still some advantages for the renter turning home buyer.
Advantages for the seller:
In a buyer’s real estate market, it can be an excellent opportunity to increase cash flow from renting a property that was otherwise vacant or difficult to sell. Most rent to own arrangements are long-term, and the rental rate can be higher than average, an advantageous arrangement for property owners.
Advantages for the buyer:
Rent to own agreements essentially allow a buyer a few years to work on improving their credit score as well as saving additional funds to go towards a down payment. If a lease option to purchase agreement has the selling price of the house, that price is locked in even if real estate values go up.
Disadvantages for the seller:
You will not be able to sell the house if the real estate market improves, and you are still within the terms of the contract signed. If the agreement includes the sales price, you will not be able to raise the price. If the buyer backs out and doesn’t improve their credit, you’ll be back to the drawing board and be stuck with a vacant rental.
Disadvantages for the buyer:
If you don’t increase your credit score, you could lose the option fee and the years of extra rent paid. Also, it’s possible something out of your control could happen; for instance, a job loss or a severe illness which could prevent you from buying.
As you can see, there are both pros and cons with rent to own for a buyer and seller.
What Can Go Wrong in Rent to Own Arrangements?
Besides the above pros and cons of rent to own agreements, there are other things you should be cautious of both as an owner and a renter. Here are some considerations to think about before entering into one of these agreements:
- The owner of the house doesn’t pay their mortgage or taxes, putting themselves into the position of being foreclosed on.
- The renter doesn’t treat the property as well as you do – letting all of the maintenance go, devaluing the property.
- While living in the property, the renter discovers problems in the house that make them not want to move forward.
- The owner passes away before the completion of the agreement complicating the transaction.
- The contract is terminated because rent is consistently paid late and the renters lose their investment.
- It’s possible a homeowner could try to sabotage the agreement so that they can sell their property for more than the stated contract.
While these are the “worst of the worst” things that can happen, it’s always essential to have them on your radar whether you are the buyer or seller.
Avoid Lease Purchase Agreements
There is a lot of flexibility in rent to own agreements—you and the seller can find terms that you both think are fair. But of all the terms you should avoid, lease-purchase agreements are the most important.
It is not a good idea to lock yourself into a purchase that won’t occur until years down the line. Many things can change, including your financial situation, so steer clear of lease-purchase agreements if at all possible.