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A simple question asked all the time, “How does rent-to-own work”? A rent-to-own agreement basically resembles traditional renting, except the lease includes a clause where after a set time the renter can purchase the house. During this time, the buyer pays rent and lives in the home and a portion of the rent payments go towards the upcoming property purchase. Because the renter is making payments towards their home purchase, the future buyer can build equity in the property before they are technically the owner. Buyers can get a head start towards building equity in a home instead of just paying someone to live somewhere. In a recent study of Millennials who would like to own their own home, nearly 2 in 3 say they will have to wait 20 years before they could afford a traditional mortgage. This is one reason Rent-to-Own is becoming so popular.
Rent-to-own contracts usually have two parts: a standard lease agreement and an option to purchase. The lease agreement specifies the rent amount, the term length, and the rights and responsibilities of both the tenant and the landlord. The option to purchase gives you the right, but not the obligation, to buy the home at a predetermined price and terms before the lease expires. To secure this option, you usually have to pay a non-refundable fee upfront, which is called an option fee or premium payment. This fee is typically a percentage of the purchase price and can range from 1% to 5%. In addition, some rent-to-own contracts may also include a rent credit, which is a portion of your rent payment that goes toward the down payment or purchase price of the home. For example, if your rent is $1,000 per month and 25% of it is credited toward the purchase price, you will accumulate $3,000 in rent credit after one year. However, not all rent-to-own contracts offer rent credit, and some may charge higher rent than usual to compensate for it.
Rent-to-own contracts can vary in their details and terms, so it is important to read and understand them carefully before signing. Some of the key factors to consider are:
The purchase price: This is the amount you agree to pay for the home if you decide to buy it. The purchase price can be set at the beginning of the contract or determined by an appraisal at the end of the lease. Some contracts may also include an escalation clause, which allows the seller to increase the price annually based on inflation or market conditions.
The option fee: This is the non-refundable payment you make upfront to secure your option to buy. The option fee can be a lump sum or a monthly payment, and it is usually deducted from the purchase price if you buy the home. However, if you don’t buy the home or fail to meet the terms of the contract, you will lose this money.
The rent credit: This is the amount of your rent payment that goes toward the purchase price or down payment of the home. The rent credit can be a fixed percentage or a variable amount, depending on the contract. Some contracts may also have a cap on how much rent credit you can accumulate over time.
The term length: This is the duration of the lease and the option period. The term length can range from one year to several years, depending on your preferences and goals. Some contracts may also have an extension clause, which allows you to renew the lease and option for another term with new terms and fees.
The maintenance responsibilities: This is who is responsible for repairing and maintaining the home while renting. Some contracts may require you to take care of all maintenance issues, while others may split them between you and the landlord. Some contracts may also have an improvement clause, which allows you to make certain upgrades or modifications to the home with the landlord’s approval.
The contingencies: These are the conditions that must be met before you can buy the home. Some common contingencies are financing approval, home inspection, title search, and appraisal. Some contracts may also have a right of first refusal clause, which gives you priority over other buyers if the seller receives another offer during the lease term.
The consequences of default: These are what happens if you or the seller breach or terminate the contract. Some common consequences are losing your option fee and rent credit, forfeiting your option to buy, facing legal action or penalties, or being evicted from the home.
Rent-to-own can be a good option for some people who want to own a home but are not ready or able to buy one through conventional means. However, rent-to-own also comes with some risks and challenges that you should be aware of before entering into such an agreement. Therefore, it is advisable to consult with a professional such as a lawyer, a real estate agent, or a financial advisor before signing a rent-to-own contract.