Housing News

Are Rent-to-Own Homes a Good Idea or a Bad Idea?

You may have heard about rent-to-own homes or even seen them advertised on a sign in or around your neighborhood. They are often aimed at those with less-than-stellar credit or who can't get conventional financing or don't have enough for a down payment. But what do most people know about them? Are they a good idea or a bad idea? Let's take a closer look at some interesting facts about rent-to-own homes.

What's a Rent-to-Own Home?

A rent-to-own home is hard to define with certainty because it is based on a contract and contracts differ. So, let's start with what we know: A rent-to-own home is the result of a binding agreement between the seller to lease a home to the buyer for a period usually ranging anywhere from 1-3 years with the option to purchase after the lease expires.

In a rent-to-own home scenario, the buyer and seller enter into a lease option or a lease-purchase option. In a lease option, the tenant has the right to buy the house (but doesn't have to) sometime before the lease expires. In a lease-purchase option, the tenant is obligated (required) to purchase the home by the end of the lease.

There is also a one-time non-refundable fee that the potential buyer must pay to purchase the home in the future. This can range anywhere from 2-7% of the purchase price. Throughout the lease period, the tenant will pay rent. Sometimes a percentage of the payment is put toward the purchase price.

The Upside of Rent-to-Own Homes

For someone wanting to "try before they buy" or live in a house they can one day own, the appeal of the rent-to-own home is considerable. The lure is equally strong for those with a low credit score or not enough money to make the usual 20% down payment of a traditional mortgage. Cash-strapped buyers are often welcomed—and even targeted—to enjoy the amenities of a rent-to-own home, while using their lease time to build up their credit and save for their eventual mortgage down payment.

If the buyer is fortunate enough to lock in a fixed-sale price at a lower market value when the lease begins, they could benefit from some serious savings versus letting the appraised value of the property determine the home sale price at the end of the lease.

Of course, this all sounds good in theory, but there are plenty of risks to consider.

The Downside of Rent-to-Own Homes

What could go wrong with a rent-to-own home? Plenty. For starters, during the lease period, the tenant often pays a higher monthly rate than what the home is worth. Also, a missed rent payment could result in the buyer losing their option to purchase the home along with everything that has already been paid. The lease-purchase option is problematic in that the tenant must buy the home by the end of the lease—whether he or she can afford it or not.

In addition, if any credit or down payment issues that impacted the tenant before entering the contract are not resolved by the end of the lease, the tenant will be right where they started—still unlikely to obtain a mortgage (and losing the money they already invested in the home).

Also, just as the buyer can benefit from locking in a fixed sale price at a lower market value when the contract is signed, the seller can gain an advantage if the home's sale price is set by a higher market value when the lease expires.

Know What You're Signing

As with any contract, it's important to know what's in it before it's signed. For instance, who is responsible for the maintenance of the home, or what if something needs to be repaired? Are pets allowed? Who pays the homeowner association dues and property taxes? It may be wise to consult with a reliable real estate attorney who can help translate all the legalese.

With that said, when you're ready to secure a mortgage, contact New American Funding. We have a variety of exciting loan options to help put you on a path to homeownership.