Rent to own housing offers many potential homeowners a way to qualify for a home purchase that they otherwise may not have. Whether the stumbling block to homeownership is a damaged credit score or the lack of a down payment – or both – rent to own requirements may be able to help you overcome these obstacles. You’ll still have to qualify, however, but the qualifications for rent to own housing typically carry more latitude than qualifying for a traditional mortgage. In certain instances, you may even be able to purchase a home with a less-than-perfect credit score if you have a job with steady income.
Exploring Rent to Own Housing
Whether you’re currently renting a home or you’re considering a different rental home with the thought of buying it, rent to own isn’t an option for all rental properties. You’ll have to find a property owner who is willing to consider renting to you for a certain length of time and ultimately selling the house to you, according to certain contractual terms. If you agree on the terms and you sign a contract, a general rule of thumb for the rent to own housing agreement is that part of each rent payment is earmarked for the future down payment on your house.
If you’ve been unable to save for a down payment on your own, a rent to own contract essentially creates an automatic savings account for you. The property owner typically deposits your additional payments into an escrow account, which should be a stipulation of your rent to own contract.
Different Rent to Own Terms
You may have to pay an option fee, commonly between 2.5 and 7 percent of the home’s purchase price, which serves as the counterpart of sorts to the earnest money you’d pay if you bought a home outright. Instead of a percentage of the purchase price, the landlord may request a flat-rate sum, such as $5,000. The option fee, also called option money, is typically nonrefundable if you default on the rent to own contract.
The rent premiums that you pay, which represent the portion of each monthly rental payment that goes toward your down payment, are structured differently with each rent to own contract. It may be a percentage of your rental payment or a set amount, so be sure to read the details in your contract.
Your rental term, the length of time that you rent, typically lasts one to three years. But it may stretch beyond this term, depending on how you negotiate the contract with your landlord/seller. And different rent to own contracts determine whether your landlord eventually becomes the seller and finances the mortgage, or whether you must qualify for a mortgage elsewhere.
Rent to Own Maintenance and Repairs
If you have a signed rent to own contract, the property owner considers you as the future homeowner instead of just a tenant. Because of this, he may require you to pay for home maintenance and repairs. Or you may have a lease agreement that relieves you of “major” home repairs and simply requires that you maintain the property in suitable shape. Yard work, such as mowing the lawn, and landscape maintenance, such as pruning, are other negotiables in a rent to own contract.
Your rent to own contract should clearly state the details of home maintenance as well as landscape maintenance, spelling out the responsibilities of the landlord and the responsibilities of the tenant. As a tenant, simple maintenance tasks such as mowing the lawn and raking leaves are a far cry from having the responsibility, for example, of repairing/replacing a roof or installing a new septic system.
Lease Option Vs. Lease Purchase
Although the two terms sound similar, and both are types of rent to own contracts, a “lease option” is different than a “lease purchase.” A lease option contract offers more flexibility than a lease purchase contract because it gives a renter the “option” of buying the home at the end of the lease term. If the renter declines the option to purchase, she may lose her option money and rent premiums, but she can walk away from the deal without the legal obligation to buy the home. In some cases, depending on the terms of the lease option contract, some or all of the option money and rent premiums may be returned to the tenant.
A lease purchase contract, however, generally gives the renter an imperative to “purchase” the home at the end of the lease term. Depending on the contract, the landlord may offer seller financing to the tenant or the tenant may be required to obtain financing elsewhere.
Qualifications for Rent to Own
Qualifying for a rent to own home follows a similar protocol as qualifying for a traditional mortgage, although the requirements may be more relaxed in a rent to own arrangement. If a landlord is planning to offer seller financing when the rental contract converts to a mortgage, the qualifications for rent to own may not include the requirements you’d find from a bank or other financing entity.
Regardless of who finances the mortgage at the end of the lease term, your lender will require a credit check and verification of your employment and income, at a minimum. Even before you sign on the dotted line of a rent to own contract, you may want to visit your banker or other lender to see if you prequalify for a mortgage.
If you don’t currently qualify, but your prospects in three years look favorable, the lender and/or your attorney can advise you on choosing a lease purchase vs. lease option contract with a three-year rental term. If a three-year projection (or two years, if your contract has a two-year term) likely has you still coming up short to qualify for a conventional mortgage, you may want to seek only landlords who offer a seller financing option at the end of your lease term. And then you’ll want to get the terms of the seller financing arrangement in writing.
Renters Vs. Homeowners Insurance
During the rental term of a rent to own contract, you’ll want to have a renters insurance policy; in fact, this may be a stipulation in your contract. Similar to a homeowners insurance policy, renters insurance covers your personal belongings in case of damage or theft, and it also covers injury and liability. But unlike a homeowners policy, your renters insurance premiums will be much lower, so you’ll want to have this coverage even if your rental contract does not require it. And of course when your rental term ends, and you’ve successfully converted your lease to a mortgage, you’ll cancel your renters policy and take out a homeowners policy.
Home Inspection and Appraisal
If you’ve gone through the process of finding a rent to own house (or you’re currently living there as a tenant) and negotiating a contract with the landlord, you may want to consider two important due-diligence steps before you sign on the dotted line. It’s impossible to assess the condition of a home at face value, unless you’re a certified home inspector or you hire one. Hidden problems can rear their ugly heads after you're into a mortgage, and you could potentially lose your home if you don’t have the funds to correct the problems. Among other items on her checklist, a certified home inspector will check the condition of the home’s foundation, electrical system, the heating, ventilation, and air conditioning system and plumbing system.
Hiring a certified appraiser is not the same thing as hiring a certified home inspector. Although both professionals will assess your potential new home, each serves a different purpose. While an inspector checks the condition of your home, an appraiser will determine the value of your home, based on current market conditions as well as recent, nearby, comparable sales. Regardless of the value a seller places on his home, which could include a sentimental or arbitrary bent, a licensed appraiser will give you an unbiased and expert opinion on the market value.
If you go forward in either of these examples, you may qualify for the home, but consider that the home may not qualify for you. And it may be wiser to move forward without signing your rent to own contract because of these findings, regardless of how much you love the house. Simply chalk up the money you spent for the inspection and appraisal as money well spent, even though you won’t be claiming this particular home as your own.
Making Rent to Own Payments
If you’ve successfully qualified for a rent to own house, negotiated the contract and signed on the dotted line, you’ll begin making payments that are differently structured than a traditional lease or a conventional mortgage. These hybrid payments are a combination of the portion that’s applied toward your rent and the portion that’s applied toward your down payment to purchase the home at the end of the lease term. Each landlord determines the portions of these payments, and you agree to the terms when you sign a rent to own contract.
As one example, your lease term may be three years, and each monthly payment is $1,200. Of that $1,200, the landlord credits 20 percent ($240) as a rent premium toward your down payment. After three years, you’ll have a down payment of $8,640 ($240 x 36 months). And if the landlord agreed in the contract to include your upfront option fee of $1,000 with your rent premiums, you’ll have a total of $9,640 for a down payment. Note that some option fees are nonrefundable, and some landlords will not include this with your rent premiums toward your down payment, but it's a negotiating point.
Is Rent to Own Right for You?
If you know a lender who can work with you to help you qualify for a mortgage loan without treading into rent to own territory, your finances will probably be the better for it. During the same three years from the example above, you pay rent during a rent to own lease term, you will spend $34,560 in nonrefundable rent [($1,200 - $240) x 36], separate from the rent premium that’s earmarked for your down payment.
But if you’re considering a rent to own house, it’s likely because you cannot qualify for a conventional mortgage due to income or credit score, or because you've been unsuccessful saving for a down payment. Any of these variables could be a result of a short-term financial difficulty, which you’ve now resolved, or they could also be the result of a long-term challenge you’ve had of sticking to a budget or otherwise overextending your financial health.
Regardless of the reason, rent to own may be an option if you don’t qualify for a conventional mortgage, you’re still repairing your credit or you’re continuing to gain ground with a new job after a stretch of unemployment.
Victoria Lee Blackstone was formerly with Freddie Mac’s mortgage acquisition department, where she funded multi-million-dollar loan pools for primary lending institutions, worked on a mortgage fraud task force and wrote the convertible ARM section of the company’s policies and procedures manual. Currently, Blackstone is a professional writer with expertise in the fields of mortgage, finance, budgeting and tax. She is the author of more than 2,000 published works for newspapers, magazines, online publications and individual clients.