What Is Rent-to-Own Housing and Is It a Good Idea?

You see these signs all the time, especially at large intersections:

“Rent To Own! No Financing Necessary!”

While I’m familiar with rent-to-own (or lease to own, as some call it) when it comes to appliance and even car purchases, I’ve always wondered exactly how this works with a house. I did some digging recently, and here’s what I found.

The Basics

Renting to own a home is somewhat similar to a car lease. The seller has given his tenant the right to buy the house at some point in the future, usually one to three years out, for a price that is agreed upon today. Generally, the tenant will pay a fee, called option money, that will keep open the option of buying.

In addition, it is common for the tenant to pay about 20% above the typical rent for the house. So if a home were to normally rent for $1000/month, a rent-to-own tenant would pay $1200. A portion of that rent will be credited to the tenant for an eventual down payment.

This can be a win-win for both seller and tenant. Many sellers offer this option if they are having trouble unloading the house and can no longer afford the mortgage payment. Often, you will find that sellers offering rent-to-own as an option are individuals who have already moved into a new home and are trying to avoid paying double mortgages for the long term.

Tenants who rent-to-own are often individuals who would have trouble buying a house through the traditional route because of poor credit, low income, or lack of a down payment. Rent-to-own gives them an opportunity for home ownership while living in the house they will eventually purchase and it also gives them a chance to discover flaws in the house before committing to purchasing it.

The Fine Print

Unfortunately, rent-to-own is not always a good deal. If the tenant decides not to purchase the house at the end of the rental term, none of the extra money that he paid to the seller comes back to him. So he would have paid above market value for a rental and have no extra cash to show for it. Furthermore, unlike in traditional rental scenarios, the tenant is often responsible for repairs and maintenance during the lease term, and any money or sweat equity you put into the rent-to-own property will not be reimbursed.

Finally, some rent-to-own agreements are worded so that you are contractually obligated to purchase the home at the end of the lease. It’s extremely important that you know exactly what you are signing if you enter into one of these agreements so that you are not stuck with a contract you cannot fulfill.

The Pitfalls

It turns out that many tenants who enter into rent-to-own agreements end up unable to buy the house at the end of their lease for the same reason they were unable to buy before: they still don’t have the credit rating, the income, or a large enough down payment. At that point, the seller walks away with a great deal of extra cash toward his mortgage and the tenant ends up with nothing.

If you are interested in a rent-to-own agreement, it would make sense to talk to a bank about financing before you sign any papers with the seller. Ultimately, however, these agreements are not the healthiest financial path to homeownership.

Are You a First Time Home Buyers? Then Read On

Buying your first home can seem daunting at first. After all, you are most likely putting down almost all your savings as down payment and also trying to obtain a very large sized loan to boot. I know that being in serious debt can seem frustrating, but homeownership can have its rewards too. The stability, the lack of a landlord, and the peace of mind can all benefit you and your family in the long run. If you are contemplating on such a large purchase, here are some timeless first time home buyer tips to help you get started.

Buy When It Makes Sense

With real estate, timing can make a big difference. Yet for most people, it’s not possible to pick the absolute bottom. Like any product where the price is affected by supply and demand, people who try to wait for the absolute bottom usually end up missing it until months (if not years) after. The better approach is to buy only when you can afford it because you don’t need to worry about the market once you are moved in. If you are very sensitive to the numbers, work out whether it makes more sense to rent instead. It’s straight forward to figure out whether it would cost less to rent a property that you are planning to buy. If this is the case, then you should consider waiting until it makes more sense mathematically to own.

Get Pre-approved for a Loan Before You Start Looking for a House

During the boom years, you can get a loan for any house you possibly want. These days, lending standards are much tougher. For first time home buyers, this is actually good because it will limit you on the houses that you can buy. If you are serious and motivated to find a home, first get pre-approved from a lender. Doing so will give you an exact theoretical maximum amount you can offer on a home, which will help you narrow down your home choice considerably (a very good thing actually as there are too many choices out there).

Consider a Shorter Term Loan

You see 30-year fixed loans as the golden standard in mortgages, but there are actually other, shorter term loan options as well. While the payments are higher, the interest is almost always smaller too. Think carefully about what is affordable to you, but opting for a 30 year, fixed interest rate that’s higher than a 15 year and moving in a few years as most first time home buyers do is throwing money away.

Work Out the Numbers Yourself

Every lender will give you different options. Discount points, loan rates, credits towards closing etc will all factor into which option works best for you. Most people just make a decision on the spot, but it’s much better to take all the options and work out the numbers yourself. There are tons of mortgage calculators available online, so do your homework and choose the option that makes the most sense for your situation.

Figure Out Your Needs and Wants

Once you have an idea of how much house you can (or want to) afford, it’s time to look at the options available. Go to Redfin.com and search for a house that fits your criteria, and make a list of your preferences. Note that the perfect home may not be possible based on your income and down payment this time around, but don’t worry because life will be very boring if you can meet all your hopes and dreams early on in life.

Be Patient

One thing to remember during this whole process is to be patient. From picking a lender to making offers on homes, the patient customer always comes out ahead. Don’t let your emotions and laziness cost you there. Home buying is a major purchase. Take your time.

Get a Competent Agent

Especially for a first time buyer, the whole process is very overwhelming. A competent agent can help answer all your questions as well as guide you through the whole process and give you advice on prices and things to ask the sellers for. Don’t make the mistake and believe that you can pocket part of the buyer agent commissions by not having one, as one mistake can cost you much more money.

In Fact, Every Transaction Should Have Two Agents

It’s perfectly legal to have one agent represent both the seller and the buyer, but it’s highly undesirable. A seller’s agent will make the case that since realtors are usually local, they will try to look after the buyer’s interest more so than the seller’s interest since they are moving away. Sure, this sounds logical, but how would the seller feel if he knows the agent is helping the buyer as well? Negotiations are a compromise between two parties, and a less than enthused seller benefits no one.

Read and Re-Read Every Single Document That Comes Your Way

Every time you are buying a house, you are helping provide a living for many, many families. Real estate is a huge industry with many smaller related businesses behind every transaction trying to sell buyers and sellers more products. Read every document carefully and make sure you know exactly what you are signing before you commit to something that you don’t know about.

Ask Every Question You Can Think of to Everybody Involved

In fact, have a notebook with you and write them all down so you don’t forget. The mortgage agent, realtor, fire insurance company, escrow company, and everyone involved all collect a fee for a decision that you are making. Ask them lots of questions, and make sure you bounce the same question off of multiple people to get a true gauge of the whole situation. The more you know, the less risk you are potentially taking.

Make a List of Everything You’ve Agreed To

Make sure that you get everything in writing. If someone promised you something, ask that person to email it to you so it’s on record. Also, there are many things you will be signing in the whole home buying process. Make sure you keep a list so you know everything you’ve signed up for. One product the mortgage company will likely sell you is an insurance policy in case you lose your job. They will give it to you free for the first year, but unless you want to pay for it to give yourself peace of mind, remember to cancel the service before they start charging you for it.

Don’t Be Afraid to Ask for What’s Fair

You may love a particular home, but don’t be afraid to negotiate. Chances are good that the agents, as well as the sellers, will work something out to accommodate your needs. If it’s a legitimate request, remember to ask.

But Before You Ask

Always seek the advice of the agent before you tell them what you’d like to ask for. Most of the time, the agent will suggest requesting for things that you haven’t thought of. But if you tell them what you’d like first, it’s less likely that they will provide an additional opinion. The other benefit is that her delivery of the request will likely sound more convincing since the request was the agent’s idea in the first place.

Other Suggestions for the First Time Home Buyer

• ARM loans – ARM stands for adjustable rate mortgages, and it can actually make sense for those who have irregular income. This is a topic that needs a much lengthier discussion and is outside the scope of this article. (Click here if you want to learn more.) However, definitely talk to your mortgage broker to hear what he/she has to say about the loan product and whether it makes sense for you. Just don’t abuse this. Getting an ARM loan is not a way to qualify for a house you couldn’t afford.
• Prepayment penalties – Make sure you ask whether your loan has a prepayment penalty. If it does, look elsewhere. Simple as that. You can double check your loan when you will receive the Truth in Lending Disclosure Statement. At the bottom of that page, make sure you see the words. PREPAYMENT: If you pay off your loan early, you will not have to pay a penalty.
• Real estate as an investment – Most people over exaggerate how much real estate appreciates. Remember that every month you are living in your home, there are many expenses that go along with it. Buy your home because of the lifestyle, and you will be much happier than thinking about it as an investment.

Tagged as: Housing, Real Estate

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