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How Do Rent-to-Own Homes Work? The 4 Steps to Homeownership

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You may be familiar with the concept of rent-to-own stores, which tend to specialize in furniture and appliances. But how does the rent-to-own process work when it comes to real estate transactions? And specifically, what does a contract like that mean for you as a buyer?

We talked with real estate professionals who specialize in the rent-to-own process in order to get an insider’s look at how to navigate the rent-to-own market from a buyer’s perspective. Their expert knowledge brings clarity and understanding to what could otherwise be a confusing transaction.

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What does rent-to-own mean?

Basically, a rent-to-own real estate purchase means that you can live in the house as a renter with the intent to close on the home at a date in the future.

Amani Warden, a real estate agent with years of rent-to-own experience in Tampa, Florida, says it’s important to realize that there are two different types of rent-to-own contracts.

  • Lease option: This type of contract gives the tenant the exclusive opportunity to buy the property at the end of the contract term.
  • Lease purchase: This type of contract requires the buyer to purchase the property at the end of the contract term.

Lease options typically require less of a financial commitment upfront. Essentially, you are paying for a first right of refusal in a lease option agreement.

Lease purchases, on the other hand, could be viewed like a traditional real estate purchase with a delayed closing date. Lease purchase agreements usually require a significant (up to 20%) investment upfront, and you are obligated to buy the house when the lease is up.

What are the steps in the rent-to-own process?

Step 1: Locate the right opportunity

Rent-to-own properties are advertised through traditional listing channels, so the best way to connect with good opportunities is by enlisting the help of a trusted and experienced real estate agent. Sure, it’s possible to dive in alone, but with the nuances of a lease purchase or lease option agreement, it’s helpful to have someone on your side.

Brenden Rendo, a real estate agent with rent-to-own expertise in central Florida, including Orlando, emphasizes the importance of working as a team with your real estate agent. “The biggest thing is making sure you have a plan,” he says.

There’s a set end-date for each contract, whether lease option or lease purchase, so you’ll want to be sure that by the time the contract is up, you’re in a position to fulfill your end of the agreement. Credit, savings, debt, income — all of that will play a role. Rendo says you need to be transparent with your agent and ask, “What do I have to do to buy this house?”

Your agent can also help vet any rent-to-own opportunities that you find. They should be able to ask the seller some qualifying questions regarding past tenants’ references, any previous rent-to-own deals, and the closing success rates for prior contracts.

In today’s market, there are plenty of private sellers and investment companies that work to provide fair deals, but there are also plenty of rent-to-own scams, unfortunately. Having an ally in your corner is the key to locating the best deal for you.

Step 2: Negotiate the contract

Once you’ve found the right rent-to-own property, you’ll need to sit down and go over the details.

As with any contract, the finer points can be negotiated to varying degrees. Watch for these keywords, and make sure they work for you:

  • Premium payment: Also called an option fee or option consideration, this is an upfront payment that will be credited toward your down payment.
  • Term: The time limit of the agreement, typically one to three years.
  • Purchase price: The price you will pay to own the home. This is typically slightly higher than current market value to adjust for inflation and motivate the seller.
  • Rent credit: Any portion of your monthly rent payment that gets credited toward the final sale as a down payment.
  • Renewal clause: An option to extend the term for a set period of time.
  • Maintenance clause: Details regarding who is responsible for repairs on the property.

In addition, you’ll want to have any inspections, appraisals, and testing done prior to signing the contract. Remember, the end goal is a real estate purchase. So whether you’re looking at a lease purchase or a lease option, it’s best to do your due diligence before getting too far.

You may also want to consult a real estate attorney to look over the contract. They can help define any terms and ensure that everything is in your best interest before signing on the dotted line.

Step 3: Pay the upfront fee

You’re sure that this is the house for you. The contract looks good. Now it’s time to make the premium payment.

Often, premium payments are non-refundable (though this too can be negotiated in some cases), so you’ll want to feel completely at ease with the deal prior to this point. The premium payment should count toward your down payment when it comes time to close on the home.

For a lease option agreement, the upfront fee usually ranges between 2.5% and 7% of the purchase price. For a lease purchase agreement, Warden says that the premium is usually around 20% of the purchase price since this type of contract requires more “skin in the game.”

Step 4: Pay rent

After the upfront premium payment, the only thing left to do is move in and pay rent like a regular tenant. If there is rent credit built into your contract, your monthly rent payments will likely be higher than the market average in order to account for the portion your landlord/seller is putting toward your purchase price. For example, if fair rent in your neighborhood is $1,500, and your rent credit is $500, then you can expect to pay $2,000 per month.

Take care not to be late on any monthly rent payments. In some agreements, one late payment can negate the whole contract. That means you could stand to lose any nonrefundable money invested. Plus, late payments could count against your credit score, which will need to be in top shape at the time of final purchase if you plan to get a mortgage loan.

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What happens after I move into a rent-to-own property?

Once you move in, you can basically relax and settle in. But it’s important to be mindful that the property is not yours yet. That means you’ll want to hold off on any upgrades or renovations that can’t be taken with you in the event that the deal somehow falls through.

For instance, it’s okay to invest money in that sleek refrigerator you’ve been eyeing (since it can be moved), but you do not want to add crown molding or change the shower tile.

As far as maintenance and upkeep, contracts vary in terms of responsibility. In lease purchase agreements, it’s more common for the buyer to be on the hook for any repairs and maintenance, while in lease option agreements, the seller/landlord will generally take that on. Sometimes an agreed-upon dollar limit is imposed — for example, anything under $500 will be covered by the tenant/buyer, and anything $500 and over will be the responsibility of the landlord/seller.

Because the seller still owns the property for the term of the contract, they will pay the property taxes, homeowner’s insurance, and HOA dues. You should, however, get renter’s insurance to cover your own personal property within the home. Renter’s insurance typically costs between $114 and $262, depending upon your location and coverage options.

Your No. 1 concern while you’re under contract should be doing whatever is necessary to get yourself to the closing date.

Remember that plan you developed with your agent? Now is the time to implement it. Sit down with your mortgage specialist. Pay down credit card debt (to get your debt-to-income ratio below 43%). Set aside money for a larger down payment in an effort to decrease PMI (private mortgage insurance) payments and decrease your rate and monthly payment overall. Whatever your personal plan entails, it’s important to follow the steps carefully and keep that end goal in mind.

What happens at the end of my rent-to-own contract?

At the end of your contract term, you’ll apply for a mortgage like any other buyer. The house won’t ever be listed for sale on the market, and the purchase price should already be defined in the contract, so at this point, it’s just a matter of finalizing the transaction.

When applying for your mortgage, make sure that your lender is aware of the complete situation. You want to provide documentation for the premium payment and rent credits that have already been given to the seller, in addition to the original purchase contract, the original appraisal (if you got one), and any inspections that were made. You’ll probably also need to obtain another appraisal. If the purchase price is significantly higher than the appraised value, you’re going to need to renegotiate with the seller or come up with the difference, since a lender will likely not approve the loan at too high of a loan-to-value (LTV).

After the closing is complete, the house is officially yours! Congratulations, homeowner!

Both Warden and Rendo agree that rent-to-own scenarios can be beneficial for buyers in certain situations. However, they’re not for everyone. Talk with your agent, and consider all the pros and cons of a rent-to-own contract, in order to make the decision that’s right for you.

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