A growing number of homes are being sold on a “rent-to-own” basis.
Here’s how it works: The potential buyer agrees to lease the home for a period of time, usually two years. The buyer also puts down a deposit (often called an “option consideration”), which is typically two to three percent of the home’s market value. At the end of the lease term, if the buyer decides to purchase the property, the deposit is credited toward the purchase price. If the buyer changes his or her mind, the seller keeps the deposit.
A typical agreement doesn’t set out the future purchase price in stone, but instead says that the current market value will be adjusted according to some measure that reflects the general trend of real estate prices in the area.
For buyers, there are a number of advantages. Most significantly, buyers who find the perfect house can have extra time to put together a down payment, pay off loans, repair their credit history, or otherwise take steps to qualify for a favorable mortgage.
Such arrangements were starting to become popular 20 years ago, but they largely disappeared during the housing boom of the early-to-mid 2000s. That’s because mortgages became so easy to come by that hardly anyone needed to wait. Now, however, with the mortgage rules having been tightened considerably, a lot of people need time to clean up their personal balance sheets.
A rent-to-own agreement can in and of itself help someone to qualify for a mortgage, because buyers can say to a lender that if they were able to make the lease payments on the house for two years, that shows that they can also make the mortgage payments.
For sellers, rent-to-own agreements can be a good way to generate additional income from a home sale, especially if they believe the local market will improve in the near future.
Here are some things to consider when looking at a rent-to-own contract:
- The contract should contain not only the lease agreement but all the terms and conditions of the potential sale agreement. You don’t want the future sale to be held up by unexpected negotiations.
- The contract should make clear who is responsible for maintenance and repairs during the rental period. Sellers may assume that the buyer is taking on more responsibility than a typical tenant, and this can lead to problems, especially since many issues may be covered by a homeowner’s insurance policy but not a renter’s policy.
- Buyers should get a home inspection before they sign, just as with a regular house purchase. You want to be able to negotiate over any unpleasant surprises – or walk away – before you agree to a sale price or formula.
- In some rent-to-own contracts, the monthly rent is set higher than the market rental rate, and the difference each month is applied to the sale price. If that’s the case, this should be spelled out very clearly in the contract. Even if the buyer and seller trust each other and have a handshake deal, a mortgage lender will want to see this spelled out.