Rent-to-Own 101 : How Does Rent to Own Work?

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Purchasing a home might be challenging if you lack the funds for a down payment, closing expenses, and the expected repairs. Renting, on the other hand, does not assist you in accumulating equity or bringing you any closer to becoming a homeowner.

Rent-to-own houses can be a terrific option to break into buying a home in a non-traditional fashion if the traditional way is not the right fit for you right now. But how does rent-to-own work out?

Rent-to-own homes appear to provide the best of both worlds, but are they a wise investment? Let’s take a look at what rent-to-own homes are and how they function to see if they’re a suitable fit for you.

What are rent-to-own homes and how do they work?

Rent-to-own arrangements can be used in place of traditional home loans. At first glance, such contracts appear to be normal leases that tenants and landlords might sign. The contract, on the other hand, gives the tenant exclusive rights to buy the house at a later date. The purchase price is reduced by a part of the down payment and a part of the monthly rent.

Such an agreement can be made between any two parties, although it is frequently utilized as a part of housing projects aimed at establishing inexpensive homes or revitalizing areas.

The purchase option allows you to purchase the home at any time during or after your lease term. The option explains how the price of the home will be determined if you decide to buy it (would it be set at the start of the lease or closer to the end?) and how your rent payments will be used toward the purchase if you decide to buy it (if at all). Depending on the market, you may have to pay an upfront cost to have this option included in the overall deal.

How Does Rent-to-Own Work?

Renting-to-own refers to a position in which you rent a house and work toward ultimately acquiring it if you decide to purchase this after your lease expires. Every month, a portion of the rental you pay to the landlord goes toward a deposit for a house on the property. At the end of your lease period, you can use the money you’ve saved to buy the house.

1. You enter into one of two sorts of contracts.

With rent to own properties, there are two sorts of legal arrangements to choose from.

  • A lease arrangement with a buy option – This contract allows you the option to buy the house at the end of your lease, but not the duty to do so. If you decide not to complete the purchase, the option will expire, and you will be free to walk away. However, you will lose the money you paid in addition to the rent.
  • A lease arrangement that includes a purchase deal – You may be legally forced to buy the home at the end of the lease if you sign this type of contract. With such a contract, you’ll want to make sure you get a home inspection to ensure there aren’t any unexpected costs once you take possession. You should also be pre-approved for a mortgage so you know you’ll be able to receive one when you need one.

2. Negotiate a purchase price.

The acquisition price of the home will be decided up front. You’ll haggle over the price with the landlord. The price could be decided by the house’s a forecasted value or present worth. So, if the seller believes that the property will be worth another $10,000 in next five years, they seller will lock that price now, and you’ll have to pay it regardless of whether the house increases in value.

When a price is set in stone before the seller and buyer sign the contract, it cannot be changed. In other circumstances, however, the rent-to-own agreement states that once the lease expires, the buyer and seller can negotiate the purchase price.

3. You decide how long the rental term will be.

In the contract, you and the seller will agree on a specified lease term. This is how long you’ll rent the house before purchasing it—usually 1–3 years. However, depending on your circumstances, the time could be shorter or longer.

You’ll also need to agree on whether you want a  a lease-purchase agreement or a lease-option agreement for your rent-to-own contract.

4. Roles for maintenance will be established.

When your landlord owns the property but you plan to buy it, you both have motivations to want to keep it in good shape—or you both may believe the other person should be responsible for it. Because rent-to-own properties are special cases, your lease agreement should specify your repair and maintenance responsibilities.

5. Pay a one-time, non-refundable charge.

So, you’ve decided to sign a contract. To demonstrate that you have skin in the game, you must now pay the seller a one-time, non-refundable sum known as option money, option of consideration, or option fee.

This secures your chance to buy the house, and the seller may put this money toward your home equity in some instances. As an option fee, you can anticipate to pay a proportion of the home’s purchase price—typically 5% or less.

6. You apply for a mortgage as the rental term draws to a close.

When you’re ready to buy a house, you’ll apply for a mortgage just like any other home buyer. Look for the best mortgage lender and loan type for you, then apply. In case your credit score is low and you’re not eligible for traditional mortgage or bank loans, hard money loans from 14th Street Capital can help you get access to funds you need. While hard money loans are typically short term loans, some lenders also give out 15-30 year rental loans with flexible amortisation options and favourable terms for the borrower. With any luck, you’ll soon be on your road to becoming a homeowner.

Keeping an eye on your money is important whether you live in a standard rental or a rent-to-own home. Here’s our renter’s budgeting guide.

Is Rent-to-Own a Sound Investment?

Buyers who don’t yet qualify for a mortgage but want to get their foot in the door—literally—might find rent-to-own programs appealing.

Rent-to-own properties, on the other hand, come with significant risks to consider. So, let’s look at the advantages and disadvantages.

Using hard money loan for rent-to-own investment

A hard money loan is considered a non-conforming, short-term loan that is provided by private companies or individuals who accept assets or a property as collateral rather than regular lenders. Hard money loans can also serve as bridge loans till the time the borrowers are able to secure alternate financing. So, while hard money is not  ideal for rent-to-own investment however, for upfront deposits and down payments, hard money loan can be easily accessible as it doesn’t require credit history and a lot of paperwork as traditional financial institution.

Bottom line

A rent-to-own contract allows prospective buyers to move into the property right away, giving them several years to improve their creditworthiness and/or save for a down payment before applying for a mortgage. Of course, the rent-to-own agreement stipulates that specific terms and conditions must be followed.

14th Street Capital, a seasoned lender, can help you get a hard money land loan. Get quick, no-hassle hard money loans with customizable terms and little paperwork.