Kim Dinan is a writer, journalist and author. She's the outdoor news editor at Blue Ridge Outdoors and writes regularly for her local paper in Asheville, NC, covering everything from the necessity of home inspections to trends in the local economy. Kim is also the author of "The Yellow Envelope," a memoir about the time she sold her house and traveled around the globe.
You’ve found the perfect home and you’re ready to do whatever it takes to make it your own. But when you crunch the numbers, you realize you aren’t in a great position to buy. You’ve heard of rent-to-own contracts, and the current owner of the home you want is willing to work with you. Now what?
Sometimes, the best option to get into the home of your dreams is a rent-to-own deal. However, rent-to-own contracts have unique components that you might not see in other real estate agreements. So, what are typical rent-to-own terms and conditions?
The first important thing to understand about your rent-to-own terms is whether you are entering into a lease option or a lease purchase agreement.
With a lease option, you have the option (but not the obligation) to buy the home you are renting when the contract is up. According to the National Association of Realtors website, lease-option agreements (aka rent-to-own) are generally utilized in residential real estate deals when a homebuyer would like to purchase a home, but needs to repair their credit rating in order to secure a promissory note and mortgage.
With a lease purchase agreement, you are legally obligated to buy the home when the contract is up.
A lease purchase agreement, however, “isn’t in the best interest of the landlord or anyone selling property, and it isn’t something I would ever advise any of my clients to do,” says Erick Monzo, a top-selling real estate agent in Detroit.
When you enter a rent-to-own contract, you likely have to pay the seller of the home a one-time upfront fee — which is usually nonrefundable. This money is called the “option fee,” and it is what gives you the option to buy the home you are renting in the future.
Keep in mind that the fee is negotiable, though it usually ranges between 2.5% and 7% of the agreed-upon purchase price of the home. You should ensure that it is clearly outlined in your contract whether or not the upfront fee will get applied to your down payment.
Just like a typical lease, a rent-to-own lease will outline the rent price in the contract. It might also outline a rent credit (a percentage of rent that the owner gives back to the renter through an escrow account because they are renting-to-own) and any additional money you will pay every month that will go toward the purchase price of the home (the down payment.)
But Monzo warns renters interested in rent-to-own contracts to enter into this type of agreement with eyes wide open. For example, rents of $1,000 per month can easily turn into a payment of $1,250 per month with a rent-to-own agreement. This is called a rent premium.
“The additional money would be deposited into a third-party escrow account,” explains Monzo. “That money accumulates, and at the end of the contract it can be used toward a down payment.”
That sounds good so far, right?
But Monzo warns that if the rent-to-own option falls apart (for example, you find you can’t secure financing to buy the house), the landlord may be able to keep all of the extra money you’ve been paying — and you still aren’t a homeowner.
Just as the cost of rent will be outlined in the contract, the price of the home should be stipulated as well. Take note that the cost to purchase might be a bit higher than the current market value in order to accommodate price growth.
“If you are going to enter into a rent-to-own contract or a first right of refusal within a traditional lease, make sure you get the purchase pricing right,” warns Monzo.
Many people who enter a rent-to-own contract don’t discuss purchase price with the landlord upfront, and this comes back to bite them later.
“Let’s say you have everything ready to go and you’re ready to buy the house and then the landlord says, ‘Great, let me get the house appraised,’ explains Monzo.
“The landlord might decide to sell the house based on the value today, not the value two years ago when you signed the contract.”
In other words, make sure you come to an agreement on the price of the house and that the agreed-upon price is stated in the contract.
Before you sign a rent-to-own contract, make sure that terms around property maintenance are clearly defined.
“Every landlord does things differently,” says Monzo. You’ll want to make sure that you and the landlord agree on who will be responsible for fixing something if it breaks, who will maintain the lawn, and who will keep up on the routine maintenance of the home, like having the systems in the house serviced.
And, as always, make sure that these aren’t just verbal agreements — they need to be outlined in the contract.
Owning a home comes with many fees, some of which might be a surprise to you if you are renting-to-own. Ask the landlord if there are additional expenses, like a homeowners association (HOA) or road maintenance fees — and if there are additional fees, make sure your contract outlines who is responsible for paying them.
Likewise, make sure that you and your landlord are clear on who will be responsible for paying the property taxes and homeowners insurance on the home during the rent-to-own period.
Make sure you go over your rent-to-own agreement with a fine-toothed comb and consider employing a lawyer or real estate agent before you sign on the dotted line. Without experts who are trained to keep your best interest in mind, you might find yourself beholden to stipulations and conditions that affect the terms of your contract.
“Renting-to-own gives you no more vested interest in the ownership of the home than a traditional lease will,” Monzo says. “Basic eviction laws still apply.”
Keep in mind, too, that if the option to buy is not exercised at the end of your rent-to-own contract, you will likely lose the option fee you paid and the rent premium.
It’s incredibly important that your rent-to-own terms lay out the specifics around renewing your contract if you aren’t ready to purchase the property when the contract is up. What happens, for example, if you still want to purchase the home but need a few more years to save? If you don’t have a renewal option in the contract, you could lose all of the money you’ve already put toward the home.
Monzo points out that every landlord draws up the contract in a different way — some of those are legal and others are not. “One landlord may have a lawyer draw up a contract; another goes on Google and finds a contract; another decides to type it up themselves,” says Monzo.
As a result, some additional rental agreement details are legal, but some are not. For example, “a landlord may say that having a pet is a cause of eviction, but state law does not enforce that,” Monzo says. “Landlords interpret the law in their own way; they are not lawyers. A lot of them put things in a contract that are not even legal.”
Monzo recommends making sure that your landlord uses a real estate agent with board approved-forms because they take out any hidden clauses and language that is hard to decipher. “You’ll know 100% that the information in those forms is legal,” he says.
Monzo says that while signing a rent-to-own contract might sound appealing, it’s not the typical way a homeowner goes about purchasing a home. By his estimate, rent-to-own contracts add up to about 5% of the leases he deals with.
“There are some landlords that only do rent-to-own. That is their business model, and that’s okay,” says Monzo. “But when you are dealing with an agent, our job is to look out for our clients and protect them.”
Header Image Source: (Jacques Bopp / Unsplash)
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