Pros and Cons of Rent-To-Own

December 12, 2016

 

Rent-to-Own contracts are a way for potential buyers to purchase a home from a seller at a pre-negotiated price at a future date.  The buyer rents the property until that future date.  The buyer also pays an amount over the rent for the seller to set aside to be used as their deposit.  these arrangements usually last 2 to 5 years.  There are several good reasons to consider a rent-to-own arrangement, but there are also serious disadvantages.  Even if you think this is an option for you as a buyer or seller, consult with a real estate attorney before agreeing to anything.

 

PROS:

  1. If a renter has a checkered credit history they may not be able to get financing to purchase a home.  A seller willing to do a rent-to-own arrangement may not need a renter with stellar credit, but rather one willing and able to pay their rent on-time.

  2. A seller haing a tough time selling their home may consider a rent-to-own arrangement to allow them to move out.  Having a renter to cover the costs of the home frees the seller's finances so that they can move on.

  3. The renter can lock in the price of the home early and thus can plan accordingly.  If the home values rise during the lease-term the renter would purchase the house for less than they might if they didn't have the contract.  In this case, the seller loses potential profit.

  4. The seller will have a long-term tenant likely to care for the property better than most and at the end of the lease-term simply sells the house to the tenant.  Additionally, since the renter is usually responsible for maintenance the seller's costs during the lease-term would be less than if this was a standard rental agreement.

CONS:

  1. If the renter terminates the lease early or decides not to purchase the house at the end of the lease-term, often the deposit is kept by the seller, meaning the renter will have to start over.

  2. Only a lender can decide how much of the rent can be applied toward a deposit when it's time to apply for a mortgage.  It's normally the amount over the standard rental rate for the area.  Renters should consult with a mortgage lender before signing to determine how much of the deposit will count when applying for a mortgage.

  3. If home prices fall, the pre-negotiated sales price could be more than the value of the home.  In this case, the renter would not be able to get a mortgage.  Either the parties re-negotiate or the renter doesn't buy.  The circumstances and how to determine the home value should be spelled out in the contract.

  4. It will be up to the renter to do their due diligence.  They should have the home inspected and appraised just like any other buyer would.  Inspections are several hundred dollars so renters should plan for these costs.

  5. Renters are often responsible for the property maintenance.  These are costs normally incurred by the landlord, but in a rent-to-own arrangement the renter takes on the responsibility of homeownership without the benefit of owning the home.

  6. If the seller is foreclosed on before the end of the lease-term the renter could be forced to move out.  Since they are not the owner, they could lose their deposit.  If the deposit is available to the owner, the owner could have used those funds for their own purposes, likely in violation of the contract.  If this is the case the renter will have to sue the owner for their deposit, which could get expensive.

There are no standard rent-to-own contracts so everything is negotiable.  Renters and sellers should consult an attorney and familiarize themselves with state and local laws.  Clearly, the downside risk is greatest for the renter.  Since these contracts are usually 2 to 5 years long and renters will still need a mortgage at the end of the lease term, renters should consider setting the deposit funds aside themselves.  During that time renters should work with a lender to improve their credit scores and in the same amount of time they likely could purchase a home of their choosing.

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