Buying a home is relatively straightforward. You find a home, you make an offer to the seller, the seller accepts your offer, and the agreement is signed at closing. In this process, typically before you make an offer, you’ll get a preapproval letter from a mortgage lender approving you for a mortgage loan in order to buy the home. After closing, you agree to pay the lender monthly payments until your mortgage loan is paid off.
Most often, you’ll need a fairly good credit score and a down payment in order to qualify for a mortgage. So what do you do if you don’t have good credit or are struggling with a lot of debt?
An option to consider is a rent-to-own purchase. But before you jump feet first into a contract, it’s essential to know and understand the risks of renting to own.
What Is Rent-to-Own?
When you rent to own, you, as the buyer, enter into an agreement with the owner of a home to pay a monthly rent for a predetermined amount of time, much like any other rental agreement. However, in this case, a portion of your monthly payments will go toward reducing the sales price of the house. After that time is up – usually from one to five years – you’ll have an option to purchase the home.
How Rent-to-Own Works
The rent-to-own process is a bit complex. It’s not as simple as paying rent and then buying a home. First, you and the homeowner sign a contract stating how much the final sales price of the home will be after the rental period ends.
The contract will also indicate how long you’ll rent the home before you have to decide whether to buy it and how much you’ll pay in rent each month. The contract should state, too, how much of your monthly rental payment will go toward reducing the final sales price of the home. It should also list what happens to any extra rent money you pay each month. In most rent-to-own agreements, that extra money is also nonrefundable.
After signing the contract, you’ll pay the homeowner an option premium. This premium gives you the right to buy the home after the rental period ends. Option premiums can vary, but they usually total around 5% of the home’s agreed-upon final sales price. It’s a bit like putting a down payment on a home.
The option premium is nonrefundable but can be applied to the home’s final purchase price. This may help when you decide to buy the home, because you won’t have to come up with as much cash at closing.
An important thing to consider that many buyers forget to include in their contracts is home maintenance responsibilities. Your agreement should state who is responsible for routine maintenance and extensive repairs. Local laws may complicate things, because in some areas, landlords are required to perform certain duties regardless of what your agreement states.
Benefits of Rent-to-Own
A rent-to-own agreement gives people who would otherwise struggle to qualify for a mortgage loan the chance to hold onto a home while they rebuild their credit, boost their income or take other steps to make themselves more attractive to mortgage lenders. The hope is that after the rental period ends, they’ll be able to qualify for the mortgage loan they’ll need to buy the home.
If you’re struggling with bad credit or are waiting for negative factors on your credit report to fade, a rent-to-own agreement may give you the time to work on rebuilding your scores. That way, once it’s finally time to buy the house, you’ll be in a better position to qualify for a mortgage.
Another benefit allows buyers to lock in a purchase price, which can be especially beneficial in a time when home prices are on the rise. If the option money or a percentage of the rent is applied to the home’s purchase price, you can also begin to build equity.
Risks of Rent-to-Own
Is a rent-to-own transaction the right move for you? It could be, but renting to own does come with its share of pitfalls. Plenty can go wrong with these transactions. It’s up to you to determine if the risks are worth the possible reward of becoming a homeowner.
If you decide not to buy the home in the future, you’ll be out of that upfront option premium payment with no home to show for it. You’ll also be out all of the extra rental money you paid each month that was supposed to go toward reducing the home’s purchase price.
And even if you do want to buy the home after the rental period, you won’t be able to if you haven’t managed to fix whatever financial problems prevented you from qualifying for a mortgage loan in the first place.
Another potential pitfall is your lack of control. Because you don’t yet own the property, you have no say in what happens to the home. Your landlord could be pocketing the rent money and not paying the mortgage, eventually losing the property to foreclosure.
You can also lose out if the home loses value during the rental period. Once you agree on a sales price with the seller, you won’t be able to change it. If you agreed to pay $200,000 for the home when you signed the contract, you’ll have to pay that same amount even if the home is now worth only $170,000.
Of course, if the home rises in value during the rental period, you’ll gain. You can buy that home for less than what you otherwise would have had to pay for it.
In some cases, if you have a late rent payment, you could lose the right to purchase your home or that extra payment for the month does not count toward the final purchase price. In other words, make sure you read the fine print in your contract and look for clauses like this.
Sometimes, there are issues with the home that you might not be aware of until you go to buy the home. The seller may have issues with the title or may not own the title, or there may be major issues that a home appraiser will not approve in order for you to buy the home. The best advice for this is to treat your rent-to-own agreement like an actual home purchase, so get an inspection and do a title search before signing anything.
Remember, before you assume that you won’t qualify for a mortgage, make sure you do your research first. We have many options to fit many different financial situations. You may actually be in a position to qualify for a mortgage and not realize it, so talk to a Home Loan Expert today.
If you have a rent-to-own experience you’d like to share, please tell us in the comments below.
Source: Home Loans