Do you want to buy a home, but don’t have the credit or a down payment?
A rent-to-buy home might be your best option. In recent years, rent-to-buy homes have emerged from the margins of the real estate industry to become a legitimate and increasingly popular option for home buyers. And considering that real estate values are going inexorably upwards, while purchasing power is declining, this path towards homeownership is only going to become more common.
So how does it work? It’s exactly what it sounds like. You sign a lease to rent a home, and part of your monthly rent goes towards the eventual price of the home. At the end of the lease, you have the option (or, in some cases, are legally obligated) to buy the home.
Those are the general outlines, but the specifics can vary widely. Rent-to-buy leases typically run between one and three years, and only a portion of your rent will go towards the eventual purchase. There are also different types of rent-to-buy lease agreements. If you have a “lease option agreement,” you’ll have the option of buying the home at the end of your lease, but if you have a “lease-purchase agreement,” that means you’re signing a legally binding contract, in advance, to buy the property at the end of the lease. So even if you decide you don’t like the house, or find something better, you’re still on the hook for the purchase.
Prices can vary, too. In some cases, the sale price is set at the beginning of the lease, often based on a combination of present-day value and projected appreciation, while in other cases, the price isn’t set until the rental part of the lease is up. So while rent-to-buy homes lets buyers avoid some of the more laborious upfront aspects of buying a home, like saving a down payment, it does expose buyers to a high degree of uncertainty.
Let’s look at some of the biggest pros and cons of renting-to-buy.
The Pros
The upsides of a rent-to-buy homes are going to have the most appeal to buyers who are on uncertain financial ground, and want to keep their options open.
Rent-to-Buy Is a Great Option for Buyers Who Aren’t Quite Financially Ready
Maybe you have a checkered credit history, or maybe you simply have no credit history at all. But for whatever reason, you couldn’t qualify for financing. A rent-to-buy home is one way around this obstacle.
Many rent-to-buyers use the rental term of their lease to get their finances cleaned up and get their credit score up, so at the end of their lease term they’ll be able to qualify for financing. And since they’re living in their future home while doing this, with a firm end date to their rent-to-buy lease, motivation isn’t a problem.
It Comes with an Easy Out
Let’s say you suddenly get an offer for your dream job, but it’s in a city across the country. If you’d purchased your home in a conventional way, you’d now have to put it on the market and cross your fingers. If you’re under serious time pressures, you might even have to cut the price to get a quick sale, maybe eating up all the profit you’ve been amassing.
But if you’re in a rent-to-buy house, you can simply walk away from the lease. You’ll be abandoning your accrued down payment money, as well as the option fee (more on this later), but that might be an acceptable price to pay for ease and mobility. Note: this only applies if you have a lease option agreement; if you signed a lease purchase agreement, you’re under contract to buy the property. Real estate lawyers and other experts can help you evaluate the lease agreement before you sign.
No Down Payment
One of the biggest hurdles for prospective U.S. home buyers is the down payment; in fact, most surveys have found it’s the number one obstacle for potential buyers. Putting 20% down on your home can be prohibitively expensive, especially for younger, first-time buyers in an uncertain economy.
How expensive is a down payment? Right now, the median home value in the U.S. is around $244,000, according to Zillow. To put the standard 20% down on that home means scraping together almost $50,000 in cash. That’s no small order, especially when you consider that 40% of Americans have less than $1,000 in savings.
A rent-to-buy lets you get around the down payment problem by essentially letting you pay it in installments, as part of your monthly rent.
Path to Homeownership
Rent-to-buy allows individuals who may not currently qualify for a mortgage or lack a sufficient down payment to eventually own a home. Basically, they get to work toward ownership while renting the property.
Test Living in the Property
Renting the property before buying allows tenants to experience living in the home and the surrounding neighborhood. They can assess whether it meets their needs and preferences, helping them make a more informed decision about sealing the deal.
The Cons
Like any deal, renting-to-buy comes with downsides along with the upsides. People who are trying to pinch every penny in the long run, and are averse to doing home repairs, should think hard before signing a rent-to-buy lease.
Expensive Rent
When you rent-to-buy, a portion of your rent is going towards your eventual purchase. For this reason, your total rent is going to be higher than the market rate; you’re essentially paying rent plus an installment of your down payment.
A typical rent-to-buy lease looks something like this: let’s say you pay $2,000 a month in rent, and 20% of that goes toward your purchase. That’s $400 a month, or $4,800 a year. If the lease runs for three years, you’ll have paid $72,000 in total rent, $14,400 of which has been credited towards your home purchase. Could you have found a cheaper place to rent? Possibly. But you certainly wouldn’t have built up that equity while you paid lower rent there.
What percentage of your rent goes toward your purchase will vary from lease to lease, so make sure to read the fine print.
Repairs and Maintenance
If you’re looking into forming an LLC to get into real estate, this is one of the main drawbacks of renting-to-buy that you should be aware of. While you’re not a homeowner (yet), you’ll be expected to shoulder one of the largest burdens of any homeowner: home repairs and maintenance.
Just as with how much of your rent, exactly, will be put aside towards your eventual home, you should make sure to look at the fine print in your lease agreement to see exactly what you’re responsible for here. It’s standard for rent-to-buyers to be responsible for home maintenance like upkeep of the yard, cleaning gutters, etc. Some lease agreements also hold rent-to-buyers responsible for major repairs like fixing a leaky roof or replacing a water heater, while other contracts may even ask buyer-tenants to pay property taxes or HOA fees. Make sure you know exactly what expenses you’re going to be responsible for, so you can budget accordingly.
A good general rule here is that you should put aside 1% of a home’s value for annual maintenance. So for a $200,000 home, you can reasonably anticipate $2,000 in maintenance a year. Needless to say, none of that money is put towards your purchase.
Limited Property Options
Rent-to-buy properties may be limited in location, type, and availability. Finding desirable ones is, therefore, challenging, as you have to compete with other buyers in an already tight market.
Nonrefundable Upfront Fees
If you opt for a rent-to-buy home, you’ll have to pay an option fee upfront. This fee is nonrefundable, and runs anywhere from 1% to 7.5% of the home’s purchase price. Think of it as a deposit or “holding fee” that you pay the owner. That way, if you do decide to walk away from the property at the end of your lease agreement, they aren’t left with nothing for their time.
Though this can seem like a lot of money to pay upfront, it’s only a small fraction of a typical down payment. Let’s say you’re paying a 5% option fee on your rent-to-buy house; for a $200,000 home, that’s $10,000. In a conventional home purchase, you’d have to put down $40,000. Of course, you’ll theoretically get your down payment back as equity, but still; it’s a lot easier to get $10,000 than $40,000.
Final Thoughts
When considering a rent-to-buy arrangement, carefully evaluate the benefits and drawbacks in light of your unique circumstances. It allows you to make clearer decisions that align with your needs and goals.
Ensure you understand the terms of the agreement, including financial obligations, maintenance responsibilities, and upfront fees. Additionally, it’s recommended to consult with experts in the real estate industry, including lawyers or agents, who can provide valuable insights and assist you in decision-making. Their expertise will come in handy in securing the best possible investment for your long-term living.
If you have several properties you want to arrange this way, consider partnering with an expert in HOA management in Myrtle Beach or wherever you are.
