Rent-to-Own

Rent-to-Own is a real estate agreement that combines a rental lease and a purchase agreement in one. The agreement states that the tenant of the property has the option to purchase it at a specified price and date in the future. This arrangement is also known as a lease-to-purchase option, lease-option, owner-financing or lease-to-own. This type of financing is not new, it has been used for a long time in Australia, but its popularity goes through cycles. When there is a downturn in the market and it's harder for home buyers and investors to get loans then this type of financing become very popular. It is a great way onto the property ladder if you need a longer period of time to save for a deposit, your credit is bad or you have other circumstances such being a new immigrant.

How does it work?
It's very important to use a lawyer to create a legal contract as they can become quite sticky if you don't understand all the details. A rent-to-own contract usually focuses heavily on the option-to-purchase section and is only fairly vague about the lease portion of the contract. This why you will need to pair it with a separate rental agreement to work out the finer details of the lease, or develop a comprehensive contract that you understand. The lease-to-own agreement is a good deal for the buyer, but you have to pay for the privilege to stay in a place and reserve the option to buy it at a fixed price. The buyer pays extra rent (rent premium) and also pays a lump sum fee (option fee) for the option to purchase the property.

So before any fees are paid, the buyer and seller have to agree on the selling price of the property. This agreed price is fixed, regardless of what the property market is doing at the time the option to buy is exercised. i.e. When it is time for the buyer/renter to either purchase the property or not. This period is usually between 1-3 years, which will also be the duration of the rental lease.

For example: Let’s say the buyer/renter and seller we have agreed to a sale price of $500,000 and an option period of 2 years. That means that buyer/renter will first rent the house for 2 years and once the 2 years is up, he or she will have the right to buy the house for $500,000 (regardless of whether housing prices have risen or fallen during that 2 years). But there is a catch. The buyer/renter must pay a fee to secure this price and contract.  This fee is often called an 'option fee', but it can be called other things, so make sure you understand this in the contract. It is usually 1-5% of the property's sale price. It is a non-refundable fee! If the buyer/renter chooses to go ahead and buy the property, that fee will become part of the down payment and the buyer/renter will need to find the remaining portion of property. If the buyer/renter decides to NOT go ahead with the sale, the seller will keep the non-refundable fee.

The rent premium portion of the agreement is that the buyer/renter pays higher-than- market rate -rent and the difference will go towards the purchase price of the house if the buyer/renter goes ahead and buys the property. So if you are interested in a $100,000 property and it normally rents for $1,000 a month, you could agree to a rent premium of $200 and lease period of 2 years.  This means the buyer will be paying $1,200 each month for 2 years. If at the end of the period the house is bought then the rent premium ($2,400) will go towards the total selling price so the buyer now owes the seller $97,600. But if the property sales does not go ahead you usually do not get this back, unless you have negotiated with the seller in the original contract.

It's important to note that at the time of the final purchase of the property and securing a mortgage with a bank or a mortgage company, that the finance company will have it's own guidelines of what can be applied to the down payment or the purchase. Typically banks only allow an amount that is above and beyond market rent to be considered for a down payment. In that case, the lease-option works as an automatic savings plan for the tenant.

Now on to the advantages and disadvantages.

The Ups

• Renters are able to put money towards the equity of their home.
• Renters are able to overcome situations that have prevented them from getting a traditional mortgage.
• Can help landlords find tenants in a down market and secure a good return on their investment.
• Renters are able to use this as a trial run as they learn what the responsibilities are when owning a home. (Could be seen as a negative to the buyer and a positive to the seller.)

The Downs

• From a renter/buyer perspective being responsible for all the maintenance of the property while renting could be seen as a negative.
• As a buyer, if you choose not to buy the home you could lose the option fee.
• As a seller, the buyer could back out of the transaction and not buy the home.
• As a buyer, a rent increment might be put on top of the typical lease payment to cover the portion going towards the down payment.
• Still no guarantee that when the purchase goes ahead that you will secure an on-going mortgage with a finance company.

Cautionary Tale 

 It may seem like a great option to buy a home, but in the US, there have been some scams.  Tenants sign a rent-to-own agreement, move in, and fix up the home. After six months or so, the landlord finds a reason to evict the tenants and keeps all of their money and their improvements. Then the landlord gets someone new to sign a rent to own agreement. In Florida in 2005 hundreds of deals were made like this, but very few people became home owners. So be aware of what you are signing.

Also remember that your contract will probably cover the following:

• In order to get a rent credit, you have to pay your rent on or before the due date of your lease (usually the 1st of the month). Any payment made after the due date will give you 0% rent credit toward your home purchase for that month, a late fee may apply, and you will not be building any equity in the house. That means none of your rent money will go towards buying the house.
• Maintenance of the home is your responsibility as the tenant-buyer. This includes things like broken windows from stones or baseballs, clogged drains, peeling paint, broken appliances, burnt out bulbs, lawn work etc. Any major repair that the house needs to be in livable condition is the owner’s responsibility. Many landlords will try to force you to pay for these major repairs as well.
• As already mentioned above the Option Fee is non-refundable of which 100% is supposed to be put toward the sale price of the house. It is not a security deposit. If you do not buy the home at the end of the lease term, or if you are evicted before you can buy the home, you will lose all of the money that you paid for the option.

Rent to own is a great option for some home buyers, but make sure you have a lawyer go through the contract very closely, and make sure the people you are dealing with are upstanding. Have you bought a rent-to-own property? How did it go, did I miss something?