Does Rent-to-Own Work?

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Rent-to-own contracts allow you to rent a home for a certain period with the opportunity to buy at the lease’s end. If you have shaky credit and need time to build it or the housing market is tough, you may consider this an option.

The concept sounds simple, but there are downsides. For one, although many rent-to-own propositions are legitimate, scammers are ready to take your money and leave you without a house. Knowing what you’re entering into gives you the power to protect your finances. Evaluate the pros and cons of a rent-to-own before handing over any money.

How Does Rent-to-Own Work?

A rent-to-own is also known as a lease purchase and is a legal contract between the seller and the buyer. It is an agreement that the seller will sell their house to the buyer at a future date.

It should not be confused with a lease option. A lease option merely allows the buyer to buy the place they are renting before it goes on the market. There is no contractual obligation on either party’s part.

With a rent-to-own or lease purchase, the renter pays extra monthly to save for a down payment. These are sometimes called rent credits or rent premiums.

There is an option fee, paid upfront, that is nonrefundable. It is usually between one and seven percent of the purchase price.

The rent credits and option fee are held in an escrow account until the renter is supposed to buy the house.

A lease purchase, however, is a contractual obligation. That means if the renter changes their mind or cannot find financing, they lose the option fee. They are also in breach of the contract and, depending on the terms, could face legal consequences.

Rent-to-Own Benefits Some People

The people usually attracted to rent-to-own are those not financially ready to purchase a house.

They may be struggling to save a down payment. Most financial institutions require a down payment, and the rent-to-own scenario makes it easier to achieve.

Other renters who want to own may need to work on their credit. A minimum credit score of 620 is usually required to qualify for a mortgage. If someone has a credit score below that threshold, it could take years to move the needle. A rent-to-own may be the best option.

Pros of Rent-to-Own

There are several pros to doing a lease purchase.

Building or repairing credit can take time. A rent-to-own agreement buys the time needed before going to a financial institution.

A rent-to-own contract will force the renter to save for a down payment. Because of how a lease purchase is structured, it helps those who don’t have the discipline to save. For example, if the rent credit is $400 monthly, there would be $4,800 after a year. When added to a deposit, like $5,000, that will add up to $9,800 after a year of renting-to-own.

If the contract lasts three years, there will be a sizable down payment.

Another pro is that money isn’t just going to rent. In a rent situation, only the landlord wins financially. But with a lease purchase, the renter has the satisfaction of contributing to their benefit and not just the owner’s.

Cons of Rent-to-Own

There is, however, a risk with a lease purchase. This legally binding contract means the renter can lose their deposit if they renege on the deal. Even if it’s because they can’t qualify for financing, the buyer is on the hook. And because it’s a contract, there are legal consequences.

Higher monthly costs are associated with rent-to-own. Yes, the extra money goes toward purchasing the home, but it could be a little hard on the budget. A simple lease may be better financially.

Because there’s an agreement in the contract on the final price of the house, a buyer could lose if housing prices go down.

A home worth $300,000 when the contract was written up may be worth $250,000 three years later when it’s time to finance. Most lenders won’t finance a house worth less than the actual value. And if they do, the buyer will be “underwater.”

On the other hand, the opposite could happen, and the house’s value increases more than the agreed-upon price. At that point, the buyer wins. But it is a risk when a buyer signs a lease purchase contract.

Scammers and Rent-to-Own

Rent-to-own opportunities that aren’t legitimate may come along. But there are several signs that a lease purchase is a scam.

The property should be priced based on fair market price. The seller will require a bigger down payment or even higher rent by overpricing a property. Underpricing is also bad. If a deal seems too good to be true, the temptation to “jump” at it may be there.

Don’t pay too much or too little; know the market. The best course of action is to consult with a realtor.

If the landlord requests money before signing a contract, it’s probably a scam. Never hand over money without a contract in place that has been reviewed by an attorney.

Some scammers will offer a lease purchase on property they don’t own. They often will list a house online they don’t own to lure unsuspecting people. Other scenarios could be unpaid taxes or the house is in foreclosure.

The buyer should always check tax records to verify the homeownership. Or better yet, consult an attorney.

Although rent-to-own providers are usually more flexible, they will still have the specific credit score they are looking for. They will run a credit check.

It may be a scam if the landlord doesn’t run a credit check or accepts abysmal credit. The seller may be trying to have the buyer pay a down payment. They know the buyer won’t be able to qualify for a loan, and the seller can keep the deposit.

What Is a Contract for Deed?

Also called seller financing, a contract deed is an arrangement where the buyer lives in the property and makes payments to the owner instead of a financial institution.

This cuts out the traditional lender and the down payment, payments with interest are all paid to the owner.

But, seller financing is risky for the buyer. The buyer doesn’t have the security of borrowing from a bank. The seller, not the buyer, owns the home. Therefore, even if the buyer is paying for it, they don’t build any equity in the house. All the equity belongs to the seller.

The biggest danger is the seller can evict the buyer at any time.

Consult a Realtor or Attorney

Although a rent-to-own can benefit individuals who don’t have a down payment to go to a bank, they should be entered into with caution.

Understand the contract and its fine print. Always consult a real estate lawyer or realtor before signing or paying anything.

The Epoch Times copyright © 2024. The views and opinions expressed are those of the authors. They are meant for general informational purposes only and should not be construed or interpreted as a recommendation or solicitation. The Epoch Times does not provide investment, tax, legal, financial planning, estate planning, or any other personal finance advice. The Epoch Times holds no liability for the accuracy or timeliness of the information provided.