Buying and renting both come with advantages and disadvantages.
Buying a house lets you build home equity, but it also – at least in many cases – requires you to save enough money for a down payment, closing costs and repairs. Renting may not involve as many costs or require saving as much money, but it doesn’t help you build equity.
If you’re torn between buying and renting, a rent-to-own home is one option that might be worth exploring. Rent-to-own homes seem to promise the best of both renting and buying, but is rent-to-own really a good idea? Let’s delve into what a rent-to-own home is exactly and how it works.
A rent-to-own agreement allows you to buy a home after renting for a period of time. You may pay a bit more in rent than the home’s fair market value, but the extra money becomes your down payment at the end of the lease.
Depending on the terms of your agreement, you may need to pay an “option fee,” also called “option money,” to lock in the option of buying the house. You usually have to pay this fee to the seller upfront, and it’s often nonrefundable.
If you don’t buy the property at the end of the lease, you typically lose the money you spent on this fee, and you also lose any extra money you’ve poured into the rent.
When you rent-to-own, you rent a property with the intention of buying it when the lease ends. Typically, a portion of the monthly rent you pay to the homeowner goes toward a down payment on the home. You have the option to use the accrued money, sometimes called rent credit, to buy the home at the end of your lease term.
Keep in mind that this rent credit is often limited to the most recent 12 months of rent and may be subject to additional loan program requirements depending on loan type.
Two major types of rent-to-own agreements are typically available: lease option and lease purchase.
Both contracts allow you to lease a home for 1 – 3 years and then buy it at the end of the term. However, the two agreements have some contractual differences you should know about.
A lease option agreement requires you to pay the homeowner an option fee when you sign. The fee is typically 2% – 7% of the home’s value.
The rent credits you save during the lease term go toward your down payment if you buy the home. In most cases, your option fee will also reduce the property’s purchase price.
You’ll negotiate the home’s purchase price with the seller and use an appraisal to determine how much the home is worth. You can let the agreement expire if you no longer want to buy the property, but you’ll likely lose your option fee and your rent credits.
A lease purchase agreement works similar to a lease option agreement. You lease a home for a few years, and a certain percentage of your rent is set aside and put toward your down payment to buy the home.
However, when you enter a lease purchase agreement, you’re obligated to buy the home at the end of the lease.
You and the seller agree to a purchase price when you sign the lease. Setting a price beforehand gives you a better idea of how much you’ll need to borrow for a loan. If you choose a lease purchase agreement, you should start loan shopping while living in the home or as soon as you agree on a price.
You lose your exclusive claim to the home and all the rent credit you’ve accumulated if you can’t get funding by the end of the lease term. The homeowner can also sue you for breach of contract if you don’t buy the home.
Should you choose a lease option or a lease purchase agreement? The answer depends on your financial situation.
A lease option agreement allows you to opt out of buying the home after the lease expires. But a lease purchase agreement requires you and the homeowner to commit to a sale at the end of the lease term. However, if the agreed-upon price doesn’t match market conditions when you intend to complete the purchase, you’ll need to renegotiate the sales price.
Talk with a local real estate agent before making a decision.