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Rent-To-Own Model Is Experiencing a Resurgence; What Does It Mean for Aspiring Homebuyers?

A comprehensive guide to understanding the nuances of rent-to-own contracts, providing an alternative for those facing obstacles in securing traditional home loans.

BY SAHIB PREET SINGH

PUBLISHED FEB 7, 2024

Cover Image Source: A sign advertises an apartment for rent along a row of brownstone townhouses in the Fort Greene | Getty Images | Photo by Drew Angerer

Rent-to-own homes: Bridging financial gaps for overlooked demographics

A 'For Rent' sign is posted near a home | Getty Images | Photo by Brandon Bell

The challenging landscape of the current housing market, marked by soaring home prices, interest rates, and reluctance among older homeowners to downsize, has left many first-time buyers struggling to enter the market. In response to these challenges, some individuals are turning to alternative homebuying options, such as the rent-to-own model, which gained popularity in the 1990s and is experiencing a resurgence.

Rent-to-own homes: A complex path to homeownership

For those unable to secure traditional mortgages due to credit score issues or lack of a substantial down payment, rent-to-own agreements present an alternative path. This model involves renting a property for a specified period, with the option to purchase it before the lease concludes. The process consists of two key components: a standard lease agreement and an option to buy.

Key considerations in rent-to-own agreements

Rent-to-own agreements necessitate scrutiny, given their complexity. Here are some crucial aspects to keep in mind:

Lease option vs. lease purchase: Understand the distinction between these contracts. A lease option gives you the right, but not the obligation to buy the home when the lease expires, offering flexibility. Conversely, a lease-purchase contract obligates you to buy the property, potentially leading to complications.

Nonrefundable upfront fees: Buyers often pay an upfront, nonrefundable fee known as the option fee which grants them the right to purchase the house in the future. This fee, typically negotiable, ranges from 1% to 5% of the purchase price.

Rent payments and purchase credits: Rent-to-own arrangements may allow a portion of rent payments to contribute to the eventual purchase price. Understanding the percentage applied and its implications is crucial.

Home maintenance: Depending on the contract terms, tenants might be responsible for property maintenance and repairs. Clarity on these obligations is vital for both parties involved.

Steps to navigate the rent-to-own process

Entering into a rent-to-own agreement involves a formal legal contract. Key steps include:

Agreeing on purchase price: Stipulate when and how the purchase price will be determined, whether upfront or at the end of the lease based on market value.

Rent application to principal: Determine if a portion of monthly rent applies to the eventual purchase price. This could offer a pathway to building equity over the lease term.

Home maintenance responsibilities: Establish who is responsible for property upkeep and repairs, ensuring that these details are explicitly outlined in the contract.

Buying the property: Depending on the agreement, buyers may need to secure a mortgage to purchase the property at the end of the lease term.

Rent-to-own: Who does it benefit?

Rent-to-own agreements can be a viable option for those aspiring to homeownership but face financial barriers. This includes individuals working to improve their credit scores, save for a down payment, or navigate nonconforming loan markets where traditional mortgages are harder to obtain.

A 'for rent' sign is displayed outside an apartment building | Getty Images | Photo by Allison Dinner

Apart from those traditionally targeted by rent-to-own options, there's a growing demographic overlooked by this industry. In high-cost urban real estate markets, where nonconforming loans are standard, financially capable individuals face challenges securing financing. Rent-to-own solutions can bridge this gap, providing flexibility to creditworthy individuals with unconventional income sources or nontraditional financial backgrounds.

Before committing: Due diligence is key

Before signing a rent-to-own agreement, careful consideration and due diligence are essential. Here are crucial steps to take:

Choose the right terms: Distinguish between lease-option and lease-purchase agreements. Understanding the implications of each can prevent potential complications.

Seek professional guidance: Engage a qualified real estate attorney to review the contract, negotiate terms, and ensure a favourable deal.

Thoroughly research the contract: Scrutinize the contract for deadlines, option fees, rent payments, purchase price determination, and maintenance responsibilities.

Examine the home and the seller: Conduct independent appraisals, and property inspections, and research the seller's background to make an informed decision.