March 2, 2024 7:13 PM
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Are Rent-To-Own Home Agreements Worth It? – The Mortgage Note

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Though it has existed since the early 1900s, the rent-to-own concept has gained popularity again and for people who want to buy a home but lack the funds, it can be an alternative route to homeownership despite the costs and risks.

Ritika Asrani, founder and head broker at St Maarten Real Estate, said with tightening lending standards many potential homebuyers are turning to rent-to-own as a way to overcome credit hurdles. She said it offers them a pathway to homeownership without the immediate need for perfect credit.

And while traditional renters typically do not build equity, rent-to-own tenants often accumulate a portion of their monthly payments as equity, which can be used toward the purchase.

What do buyers need to know before they sign a rent-to-own agreement?

These contracts often include an agreed purchase price and there are ways to make sure the value is correct.

“Some contracts include provisions for appraisals before the purchase,” said Asrani. “If the appraisal comes in lower than the agreed price, tenants may have the opportunity to renegotiate or walk away.”

The language used is extremely important. There is a difference between lease-purchase and lease-option agreements.

“In a lease-purchase, tenants are obligated to buy the property, while a lease-option gives them the choice,” said Asrani. “The terms can have significant legal and financial implications.”

Rent-to-own contracts are highly customizable.

Asrani added that homeowners should work with legal professionals to draft agreements that protect their interests and outline all terms clearly, including rent credits, maintenance responsibilities, and what happens if the tenant chooses not to purchase.

How do these agreements work?

Garrett Ham, principal broker and CEO at Weekender Management, Inc., said rent-to-own agreements usually involve an initial option fee, which is often a percentage of the home’s price, and an elevated monthly rent.

These additional costs are typically credited toward the eventual purchase price. For example, Ham said a $5,000 option fee on a $250,000 home would reduce the purchase balance to $245,000 at closing, while an extra $100 per month in rent over two years could decrease the balance by another $2,400.

Ham said sellers might be less flexible on price negotiations in a rent-to-own deal compared to immediate purchase offers. However, the advantages include price security against market inflation and the chance to build equity through rent.

“If property values decline, the buyer might choose not to exercise the rent-to-own option and could attempt to negotiate a new purchase price, though this is contingent on the seller’s agreement and does not recoup the initial option fee or rent premiums,” said Ham. “If the property value increases, however, the buyer may have a really good deal that could make financing the property even easier.”

Before entering a rent-to-own agreement, buyers should thoroughly examine it, particularly the due-on-sale clause. This clause may allow the lender to demand full repayment upon the transfer of property interest, according to Ham.

“In addition, if the potential buyer is unable to fulfill the purchase for any reason, the option fee and extra rent premiums are forfeited,” he said. “Finally, the buyer generally assumes responsibility for most maintenance costs during the rental period, which could add additional unforeseen expenses.”

The cost of homes is at an all-time high in many markets, so rent-to-own is one way for potential buyers to get a foot on the homeownership ladder.

Neil Anders, host of the Emmy-nominated television program “Financing the American Dream” on CNBC and Bloomberg, said renting a home first can be more appealing than buying in some situations.

“These days, it is frequently simpler for consumers to sign up for rent-to-own contracts than it is to make an outright property purchase. It provides them with an opportunity to acquire something they truly desire while they accumulate the funds required to make the full purchase,” Anders said.

Michael Branson, CEO of All Reverse Mortgage, Inc., said there are distinct advantages to this approach.

“It allows potential homeowners to move in immediately while still working towards ownership, and it also provides an opportunity to lock in a purchase price at the beginning of the agreement, potentially saving money if the property’s value increases over time,” said Branson. “It’s a way for individuals to enter the housing market without having to come up with a large sum of money upfront, making it a more feasible option for many.”

Branson added that it is essential to research and compare different options, understand all the terms and conditions, and seek professional advice if needed.

“Unlike traditional rental agreements, if a renter is late or misses a payment, they may forfeit the entire investment, including any down payment and rent premiums paid to date,” said Branson. “This can be a significant setback for individuals who are already struggling to make ends meet.”

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