Just a few years ago, you hardly ever heard the term "rent to own" in a market where homeowners had multiple bids from which to choose. But now, with so many homes languishing on the market, it's a different ballgame. Homeowners are more willing to work out rent-to-own agreements, even with people who would be turned down for home loans.
A rent-to-own contract requires prospective buyers to pay monthly rent to the homeowner, with a portion of it going toward a home purchase at a later date. This contract usually lasts two to five years at which time both parties start the standard home purchase, says Rich Arzaga, a financial planner in Walnut Creek, Calif., who has taught commercial real estate investment at University of California, Santa Cruz.
"If you've had your house on the market for a while, this transaction could let you move while having someone in your house generating cash flow for your mortgage," says Ron Phipps, president-elect of the Washington D.C.-based National Association of Realtors.
For wishful homebuyers with checkered credit histories, it's a homebuying option worth considering, says Sam Tamkin, a real estate attorney in Chicago. "You may be unable to qualify for a loan right now, but there are sellers who may be willing to consider renting to you with an option to purchase later."
Pros and cons for both parties
Besides having time to build up a down payment and good credit record, renters have the advantage of "trying out" the house and neighborhood, says Arzaga. "You can also lock in the sales price and terms upfront, allowing you to purchase the house at a below-market price in a few years," he says.
Not all the money you pay in rent will go toward the down payment. "Mortgage lenders are the ones who decide how much of your rent payments are credited toward the down payment and closing costs," says Phipps. Most lenders will only allow a credit for an amount paid above the market rate for local rentals to be held for eventual homebuying costs.
For example, the house could be rented by its owner for a standard rent of $1,750. But when negotiating the rent-to-own contract, you and the homeowner can agree that you will pay $2,000 a month, with $250 as your homebuying credit. At the end of a three-year lease, you'll have $9,000 set aside. That money is returned to you at the time of settlement and can be used for your earnest-money deposit, down payment or closing costs.
If you decide not to buy the house at the end of the lease, you probably won't get a refund. That money is usually only returned to you when you buy the property, says Phipps.
For sellers, the advantages are having an eager buyer and a long-term renter who will care for the house more than the standard tenant. However, there's a risk of the renter opting out of buying your house at lease's end, making you go through the listing process again, Tamkin says.