When it comes to “Rent-To-Own” or “Lease-to-Own” homes:
You’re about to learn why this could be one of the worst mistakes a buyer could possibly make.
Are there any positives? Sure there are, and we’ll discuss those as well.
First off, every person’s situation is different. In some rare cases, this may be your best option, but typically, this kind of arrangement is extremely disadvantageous to the buyer.
The best way to explain this concept is with a specific example:
- Lets assume that for whatever reason you are either unable or uninterested in purchasing a home through a more conventional way.
- Lets also assume that you found a home you really liked and have agreed on a purchase price of $500,000 for this home.
- Finally, lets assume that the market rent for this home should be about $2,200 per month.
“Luckily” for you, you’ve found a seller that is willing to give you a Lease Option, which is another word for rent-to-own. The reason it’s called a lease option is that after a pre-determined period of time leasing the home (typically about 3 years), you will have the option to buy it for an agreed-upon price.
The first step is negotiating your contract with the seller. All sellers want a lump sum upfront (typically around 5%), and after a little negotiation, this is exactly where you end up: 5% or $25,000. This money is paid to the seller up front, but will be applied towards your down payment once you decided to buy.
Next you negotiate rent. All sellers expect above market rent, but this one tells you that anything over market rates will be applied towards your down payment. You negotiate a rent of $2,500 (fairly typical). Which means that $30o/month *12 months * 3 years = $10,800 that you are “over-paying”, will be applied towards your home purchase.
Lastly, is an unexpected issue of repairs and maintenance. Since you are not only the tenant but the future owner of the home, it is most common that you will be the one responsible for the cost of repairs and maintenance. There is no pre-defined number here, but lets just say conservatively an estimated $3,000 over three years.
At this point… this isn’t such a bad deal or too unexpected? Right??
Well yea, if you end up buying the home, it’s not such a bad deal.
But what happens if you don’t buy the home?? – If you don’t buy the home, you will lose almost $40,000 over three years.
Now I know what you’re thinking, “Why wouldn’t I buy the home?” – Great Question 🙂 – I’ll split up the answer into two sections:
- You changed your mind.
- It’s just not as big as you thought
- You can’t stand the neighbors
- The home makes weird noises or has ghosts … or any number of reasons where you just changed your mind.
- Home prices in the area are starting to decline and you realize that this is not the time to be a home-owner.
- After conducting inspections that you didn’t previously do, you discover issues that you weren’t aware of before… such as cracks in the foundation or other “big deal” items.
- Job Loss
- Death in Family
- Addition to the family
- Relocation (work or otherwise)
- You try to buy the home but your financing falls through: (Is that really likely? – YES! It’s VERY likely– Who knows what’ll happen in 3 years!
- Interest rates might be higher than they were 3 years ago and you can’t afford the monthly payments
- Your family income or expenses changed and you’re no longer qualified for the same rate/loan
- The home has lost value and only appraises for $450,000 so you would have to pay the difference.
- Any number of other changes that could effect the lending climate and make you unable to qualify for a loan.
The point I’m trying to make is that even if you don’t consciously change your mind, there is a very high risk of “something” coming up and making you unable to purchase in the time-frame of the option.
What if your roof leaks, and there is just no fixing it – it has to be replaced and there’s an unexpected cost of $10,000+
And what happens if 2 months later (around year 2) you lose your job and can’t make the rent payment?? … The agreement is cancelled and your money is gone.
Lastly, what if you do everything right, but the seller has financial problems and stops making loan payments. The home will be foreclosed on, your contract will be terminated, and you will once more lose your entire investment.
So all of the risk is on you as a buyer, while all of the rewards go to the seller.
In my opinion, the far better option is to rent for 2-3 more years, improve your credit, save extra money and then buy a home the regular way without any of the risk.
I did mention that there are positives … but the fact is, I can only think of one positive:
- If real estate prices in your area are increasing rapidly, like perhaps in 2005-2007, then this is a good opportunity to lock in a home price before it gets out of your reach. That same $500K house today might be worth $700K in 3 years. – This of course should not be an issue in today’s market.
If you’re still thinking about pursuing this option, please send me an email because I would be very interested in hearing your logic.
Or if you’d like, I can recommend a fantastic mortgage expert who can guide you from which-ever financial point you’re at now, to where you need to be to become pre-approved for a loan. That way, 2-3 years from now you will be buying a home without any of the risks above.
And, as always, if you have any questions, I’d be happy to discuss this topic, or help you analyze your particular situation. CONTACT US today for a free consultation!
November 19, 2011 at 12:52 pm
Muchos Gracias for your article post.Really thank you!
September 7, 2012 at 7:36 pm
This seems to be a very biased article written by someone who is essentially “cut out of the deal” when sellers sell their property using a rent-to-own format. With rent-to-own deals real estate agents aren’t often used saving the seller (and buyer) roughly 6% in agent commissions as well as money on closing costs. Rent to own can be a great method for someone with some credit issues to get into the right home for them right now instead of in two to three years. The market is turning and rent to own tenants will likely see a return on their investment in two to three years. Great way to lock in all time low prices right now! While there are some people out there touting marketing rent to own properties to folks who might not ever qualify for the loan to buy the property, a savy buyer can get into a home and give themselves the best chance to ultimately buy that home.
September 7, 2012 at 10:07 pm
Hi Kelly, thank you for your comment!
Believe me that the last thing on my mind when posting this article was being cut out of the deal … there is no shortage of business out there 🙂
Rent to own might be the only method for certain buyers to get into a home, and if that is the only option it might certainly be worth persuing.
To your point that the market is turning, I’ll ask you this … Why would a seller, who knows the direction the market is going agree to rent-to-own instead of just renting and selling for more in 2-3 years? The only answer is all of the seller benefits I discussed in the article. Chances are something will derail the transaction and the seller will end up keeping the home and the deposit, while having a renter for those years. Great deal for the seller, bad deal for the buyer.
Is that always the case? Absolutely not! There is no always in real estate, but it is BY FAR the most likely outcome.
If you are currently renting-to-own, I wish you the best of luck and sincerely hope you don’t end up losing your investment.
June 5, 2013 at 8:57 am
The one thing that didn’t make sense about what you said and I agree with most of it is that you lose 11,000 over 3 years as reason not to..but then you said to rent for 3 years..which is far more money.
The only reasons I would consider this for myself is currently not great credit..in face horrible credit. This would allow me to put far more money down towards the house than I would be able to save while paying around the same amount of rent. So while building a far larger down payment than I could have saved I can rebuild my credit by paying off debt instead of saving money for a home I don’t have the credit to purchase. That makes more sense to me…but I do have my doubts.