What Is Rent to Own?
I often come across people looking for houses that are rent to own. The reason many people look for these houses is they believe they are not in a financial position to buy a house in the traditional way for many different reasons, yet they still have the desire to own a home. However, I have also found that many of these people hold a common misconception about what rent to own actually means. Truth be told, I had this same misconception before I became a real estate agent. So, what misconception am I referring to?
Many people think that rent to own is basically just renting a house for a certain amount of time and then at the end, you now own the house. So, you come in with your security deposit and first and last month's rent. Then you pay your rent, which is actually going to pay off the house. And then after a specified number of years, you have your own house!! In other words, people believe that rent to own means that you are renting the house in order to eventually own it.
Unfortunately, that's not really what rent to own means. In real estate, rent to own refers to what is actually known as a lease option or lease with option to buy. This is similar to a car lease, except with a house. In a lease option, you agree to rent the house for a specified amount of time and then have the option to buy the house at any point during or at the end of the lease period. In turn, your landlord agrees not to sell the house to anyone else until the option period ends. You would both sign a contract binding you to these terms. In other words, rent to own means that your rent converts to ownership, should the contract be fulfilled.
Lease option contracts can contain different terms. But there are some things that you will commonly see in a contract. First, it's common for the landlord/seller to ask for option money upfront. Basically, this is money that you pay in order to reserve first rights to the house. This option money may or may not go towards the purchase of the house. Second, the rent you pay every month during the option period most likely will not go fully towards the purchase price of the house. In fact, with some contracts none of that rent will go towards the purchase of the house. In other contracts, a portion of the rent will go towards the purchase of the house, but you will often pay a higher rent amount when this happens. Lastly, should you not purchase the house within the option period for any reason, any and all money you paid up until that point will be forfeit. This means that when you don't purchase the house, you lose your option money and any extra rent you may have paid.
Rent to own can be an option if you do not have the credit in order to go through a traditional home purchase because it gives you the time to repair your credit. However, it may not be the best option for many people because you have a very good chance of losing the money you put towards purchasing the house.
There is another type of purchase that resembles the common misconception of rent to own, which is owner carry or seller financing. In this type of contract, the owner/seller of the house finances the purchase. In other words, instead of borrowing money from the bank, the owner will sell the house to you and then you pay all your house payments to the seller. This can be another option for those who do not qualify for a loan through a bank or mortgage broker due to credit. However, seller financing contracts often require large down payments because the seller needs some guarantee that you will actually make your payments. In addition to this, many times seller financing contracts will have higher interest rates than the current interest rates offered through a traditional lender.
One reason people might look at these options is because they feel like they do not have the money for a down payment. However, both of these options will most likely require money up front. And there are loan programs available that require either a low down payment or no down payment at all. So, if lack of a down payment is what is prompting you to look at other options, it may be a good time to talk with a lender and see if you qualify for any of these programs.
Owning a home is a dream that many people have, but many people also often find themselves in situations where they think it's not possible. Rent to own houses (lease options) and seller financing are two options that may give people who don't qualify for a loan based on credit will often consider. However, both of them do have disadvantages that should be considered before going that route. For many people, continuing to rent while getting credit counseling or credit repair help to establish credit or raise their credit score may be their best option. That may not be what most people want to hear, but when getting ready to make what may be the largest investment of you life, exploring all options and understanding the pros and cons of each is the wisest thing to do.