If you’re like me, you’ve often dreamed of owning a home, only to get a rude awakening when you start doing some research. Here in San Francisco, where the median home price is $900,000, cost is the biggest dreamkiller. Even in less expensive markets (aka everywhere else), the lack of a down payment is often a barrier. And other would-be homebuyers find they can’t qualify for a mortgage due to bad credit, insufficient income, or too much debt.
But, before you resign yourself to being a renter forever, here’s an option to consider: rent-to-own. It’s not just for furniture anymore.
How rent-to-own works
Rent-to-own agreements (also called “lease options”) serve 2 purposes: they help owners tap into a larger pool of potential buyers, and they help prospective buyers achieve their dream of ownership while giving them extra time to improve their financial circumstances.
The transaction goes like this:
- The owner and intended buyer agree on a future purchase price for the house.
- The owner and buyer commit to a lease period (usually between 1 and 3 years). During this time, the owner can’t sell the home to anyone else. Note, though, that the potential buyer is generally not obligated to purchase the house at the end of the term.
- Before moving in, the buyer pays an “option fee,” which is essentially a non-refundable deposit. It’s typically 1 to 3 percent of the purchase price.
- While living in the house, the buyer pays their monthly rent as well as an “option credit.” This credit is applied to the final purchase of the house.
So, instead of your rent money disappearing every month, a portion of your cash will go towards purchasing your dream home. Sweet!
But don’t sign that agreement just yet.
Considerations for potential buyers
A rent-to-own agreement is not a guarantee that you’ll be homeowner at the term’s end. You’ll also have to give up certain advantages of being a renter. Here are a few things to bear in mind.
- If you decide not to (or aren’t able to) purchase the house, you’ll forfeit your option fee plus any option credits you’ve accumulated.
- As the prospective owner, you’re responsible for all repairs to the property — no calling the landlord to replace your broken washing machine or fix your leaky pipe (because there is no landlord). Be sure to get a professional home inspection before signing the agreement so you know what condition the house is in.
- Due to the option credit, your monthly payment will be somewhat higher than if you rented the same property under a standard lease.
- If you’re late with the rent, your option credit will typically be voided for that month — meaning that much less cash in your home-buying kitty.
- If the owner defaults on the mortgage, the house could go into foreclosure. (One way to protect yourself is to have your payments go directly to the home lender.)
There’s also the question of availability. In the Bay Area, where competition for homes is causing insane bidding wars, there aren’t many rent-to-own properties on the market. But, if you live in an area with a surplus of homes for sale, you’re likely to see a lot more listings.
Considerations for owners
If you’ve had a hard time finding a buyer because you’re in a saturated housing market, rent-to-own might work for you.
Here are some pros:
- The option fee and monthly rent can be a welcome source of extra income (and you’ll get to keep the option credits if the buyer backs out)
- Potential buyers often treat the property and the neighborhood better than renters because they’re more invested
- You can potentially lock in a higher sale price if property values are falling
But, if you need the money from a full sale right away, rent-to-own probably isn’t for you. Here are some other caveats to consider:
- If property values go up after you lock in the price, you’ll have to sell your home below market rate
- Despite their best intentions, your would-be buyers may not manage to sufficiently improve their credit or raise enough funds to buy the house
- If you get a favorable offer from another interested buyer during the lease option period, you’ll have to turn it down
- You’re still responsible for insurance, property taxes, and any HOA payments as well as your mortgage
Whether you’re a seller or buyer, rent-to-own agreements can be tricky, so be sure to have an attorney look over the contract.
And, of course, if you’re a current homeowner (or about to become one), you’ll need to have the right homeowners coverage. We’ll be glad to help you out.