It can feel like spending thousands on rent every year is a bit of a waste of money, but buying property might not always be an option. While scrolling through rental listings online you may have come across rent-to-own ads. These listings often paint an appetizing picture where bad credit and low income don’t have to stop you from owning your home.
So what’s the deal? The basic idea of rent-to-own is that you sign a contract for two or three years with a property owner, and part of your rent will go towards a downpayment on the house that you are renting. Once the rental lease is up you should in principle be able to purchase the property.
So how does it really work?
Just like a regular rental you will sign a contract, a lease, with the property owner. This contract is usually set for two or three years and will stipulate all of the terms and conditions that both parties agree to. You may also be required to pay an option fee (2-8% of the property’s market value) upfront that will ensure you maintain first choice on the property once your contract is up. Your monthly rental fee also includes a predetermined percentage that the owner will place in an escrow account. This amount will go towards your downpayment on the house if you decide to purchase (and will usually be lost if you don’t). Typically all of the fees are worked out with the owner based on the current market value of the property. This price is then locked in and will be the price you pay for the property at the end of your rental contract (minus any monies you have paid along the way).
Should you do it?
It can be a win-win situation for both parties, but this is not something that you should jump into without a lot of research beforehand. For the owner there is mainly the advantage of making money during the leasing period and having an easy sell at the end. For the tenant it can be a great path towards owning a piece of property while building up credit. But it is often not as smooth sailing as it looks on paper.
First of all, signing a rent-to-own contract does not guarantee that you will be able to get a mortgage once your lease is up. As a tenant you may have been super vigilant in paying your rent on time, maintaining the property, and basically being an all-around model tenant, but when it comes to crunch time you will lose out on buying the property and all of the money that you have put towards it because you are not able to secure a mortgage. Before signing a rent-to-own contract it is always vigilant to talk to a mortgage broker to see what you need to do in order to be able to be approved for a mortgage within the following two or three years. It may be just an issue of building up a better credit score, but there could be a lot more work at hand.
Other downsides could be seeing the property value tank, finding out you aren’t interested in owning property in the area anymore, or just not being able to meet all of the contract’s terms and conditions on a regular basis. Even paying one month’s rent slightly late could mean you lose out on the deal. And another obvious issue is that not all of the rent-to-own deals advertised are above water, and you should always do some extensive research on the owner before signing anything!
Should you do it?
Most financial advisors will advise to continue to rent, save for a downpayment, and work on building your credit up instead of signing a rent-to-own contract. Rent-to-own may work out well for you, but in the end it requires a lot of commitment, longer than a standard rental lease demands, and you need to be 100% sure that you are willing to make this commitment.