Rent-to-Own Buyer's Guide
The rent-to-own process comes down to the contract and one caution: Buyer beware. While rent-to-own, also called lease-purchase or lease-to-own, can amount to a "win-win" for both buyer and seller, it can also amount to a scam on the buyer. The contract wording is the key to the difference.
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Chief Elements
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A rent-to-own contract combines a lease with a purchase agreement. There is no standard format, so it is extremely important to go over all of the fine print. The contract includes the monthly rent and either a price for the property or a process by which the price will be determined in the future. It specifies a date by which the property must be purchased or a window of time during which the property must be purchased. Often, it includes a nonrefundable option fee -- essentially the fee you pay for the right to purchase the house under the specified terms. The rent is often more than you would pay for the same property as only a rental, but some amount of the rent is credited toward your down payment. If you do not exercise the option, you lose the option fee.
The Best Contracts
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If the contract price for the property is specified, as opposed to a process by which it will be set later, and the price reflects the value of the property at the time you sign the contract, you will benefit greatly from any appreciation during the option period. In an appreciating market, this can be a boon. You will walk into equity the moment you take title because the property's value will exceed its cost. In a flat market, there is no advantage to rent to own. In a depreciating market, you would end up paying more for a property than it's worth. The option fee should be reasonable -- something under two months' rent. The lower the fee, the better the deal. Likewise, the rent should not be too much above market; otherwise, you would be better off renting a home until you can save for your down payment on your own without risk of losing it.
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Unsavory Contracts
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If, instead of a set price for the property, the contract describes a process by which the price will be determined when the option is exercised, you will be paying an option fee for an unknown quantity. It's like risking money for what's behind "door number one" instead of taking guaranteed cash. If the market has appreciated, the price will be higher than it would have been when you first signed the contract, and you will not benefit from the appreciation that occurred in the meantime -- the landlord will. You will be better off renting and saving for a house on your own. If the contract presents a very narrow window of time, in the not too distant future, during which you must exercise the purchase option, your risk rises. If your credit needed repair when you signed the contract or you need time to save for the down payment, the terms may not provide you with enough time to exercise the option.
The Importance of Credit
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Some landlords chose their rent-to-own prospects by the tenants' poor credit scores. A landlord knows it is highly unlikely, especially at a time when loan qualification standards have risen, that a tenant will qualify for a mortgage by the time the option period expires. If the tenant can't qualify, he can't buy the property, so he loses the option fee -- the higher-than-market-rate rent. And then sometimes the landlord will evict the tenant, so the landlord starts the process all over again with another prospect. Before you sign a rent-to-own contract, speak with a mortgage broker or credit counselor to understand what you will need to do in order to qualify for a mortgage. If it can't be done within the option period, save yourself some money and walk away from the deal.
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References
- Photo Credit contract 20309 image by pablo from Fotolia.com
