If you’ve ever rented a home, you’ve almost certainly felt like you’re simply throwing away your money at least once. In this regard, getting a mortgage seems like a much better solution because even though you’re making monthly payments just like with rent, the money is not actually disappearing, as you’re usually building equity on your home. But did you know that there’s a third option? You can rent-to-own a house and combine the benefits of renting and buying a property.
What is rent-to-own?
Rent-to-own is a concept that lies somewhere between renting and buying property. When you rent to own a home you sign two contracts - one is pretty much your typical lease, except that the term of the lease is usually 2-3 years and one of the stipulations may be that you’re responsible for minor repairs and upkeep of the property. The other contract you sign is the lease option, which gives you the exclusive right to purchase the home for the duration of your lease. When you rent to buy a house, you will have to pay an option fee upfront for the right to buy the home without worrying about anyone beating you to it. This sum usually makes up 2-7% of the purchase price of the house and when you decide to buy the home, it goes towards your payment for the home but if you decide not to buy, you lose that money.
How much do rent-to-own agreements cost?
From the financial point of view, renting to own is more complicated than a simple agreement. First of all, most of the time the owner of the property and the future tenant/buyer agree on the price of the home before signing a lease or a lease option, so you need to make sure you negotiate a fair price right away. Secondly, you need to pay a percentage of the home’s price as the lease option fee right away. Finally, you can expect to pay a little bit more rent than if you were simply renting the home without an option to buy it later. This is because a portion of your rent will go towards your future purchase of the house, so if you want 20% of your monthly rent payments to go towards a home payment, your rent will exceed the market rent by 20%. At the end of your lease, if you decide to buy the home, you will have already paid off a portion of its price through rent payments, a previously agreed-upon part of which went towards your home equity, and the bulk lease option payment. If you decide not to buy though, you will lose all that money.
Pros and cons of rent-to-buy agreements for buyers
In certain situations, rent-to-buy agreements can be incredibly useful and beneficial to both buyers and sellers. Rent-to-buy houses are typically perfect for buyers who can’t get a mortgage through traditional means but want to start building equity on their future home right away. A rent-to-buy agreement can give you some time to save up for a downpayment or to improve your credit so you can get a mortgage at the end of your lease term. Plus, it’s a great tool if you want to lock down the price of a home in an up-and-coming neighborhood but can’t afford a mortgage yet. Finally, you can choose a rent-to-buy agreement if you want to check out the neighborhood before actually buying the house, although choosing not to buy will cost you a lot of money.
The cons of renting to buy for buyers include the fact that if you can’t get a mortgage at the end of your lease term, you will lose lots of money you’ve paid towards the eventual purchase of your home. Another con is that the price of the house may drop during the term of your lease. Plus, you always need to make sure that your landlord is financially stable because if they default on their mortgage payment and the house is foreclosed, you’ll lose the money you’ve paid.