A rent-to-own home is an arrangement that allows you to own a house in a situation where you don't have the financial capacity to purchase the property immediately.
If you’ve read our article on How Homeownership Builds Wealth, you’ll know that owning a home can increase your long-term wealth. But if you aren’t in the position to outright buy a house right now, this could be a good alternative for you.
Basically, this is an option for all of y’all out there who haven’t taken WealthStack’s advice and gotten your finances in order (get in touch so receive our free guide that’ll help you start). The idea with these types of homes is that they’re a great sort of “in-between” for those who don’t have the required credit rating, income, or down payment to purchase a home they want to eventually buy.
What do you need to know, and how can we give it to you in the simplest way possible? Here’s everything you need to understand about rent-to-own homes — the good and the bad, so you can decide whether it’s a fit for you or not.
How do Rent-To-Own Homes Work?
How it works is simple. You commit to a contract that allows you to rent a house with the option to buy the house after an agreed period. Well, it’s simple in theory. There are a few other things you have to agree upon with the seller, including...
The Purchase Price
This is usually the first thing you have to agree with the seller. With the rent-to-own option, the price is usually slightly higher than what you'll get it for if you're buying on normal terms.
You’re not buying the home straight up, which means that you have to agree on a monthly rental price. This is one of the biggest downsides of a rent-to-own home; rental prices are usually a bit higher than they are for a regular house.
For example, if the normal cost of renting the house is $1000/month, you may be required to pay $1200/month. However, this additional fee will be credited to you as a down payment for the house, so it works out in the long run.
Usually, in a rent-to-own home agreement, you're responsible for repairing and maintaining the property during the lease period. While this isn’t how it works when you’re renting a regular home (unless you host a massive party and the damage is all your fault), it’s a great way to prepare you for full-on homeownership.
When that house is your property and your capital, you won’t be wanting to damage it. So, start acting like it’s already yours and treat it that way.
This is where things get a little less than ideal, especially for folks without much cash on hand to invest with initially (that’s why you’re renting-to-buy, right?). You’ll have to pay option money or an option fee, which is non-refundable.
This fee is usually less than a down payment, but it’s basically a down payment of sorts. You’re paying a fee to sort of “hold” the house until it’s fully yours when you’re ready to buy.
The Option To Buy Agreement
This is the formal agreement or contract that you and the seller will sign. Usually, it’s called a lease-option or lease-purchase (if you don’t see this, ask for it because it’s crucial!).
With the lease-option, you have the right, but you're not obligated to buy the house when the agreed lease period ends. With the lease-purchase contract, you're obligated to purchase the house at the end of the lease period.
A Real-World Rent-to-Own Example
If you’re the kind of person who does better with real-life examples, then we’ve got one especially for you!
Let’s say that you’ve found a great rent-to-own home for $250,000. The option fee is 2%, which means that you’ll pay 2% of $250,000 (and remember, that fee is non-refundable). This means that you’ll need to have $5,000 cash on hand to sign the contract. Once you pay and sign, you can start renting the house formally.
Let’s say that your monthly rent is $1,500, but 20% of that goes towards the home’s purchase price. This means that you’ll technically be paying $300 a month towards purchasing your home. And you'll be doing it all without ever making a massive down payment. And your friends livin’ it up in NYC paying $2,000 for a tiny apartment? You’re laughing because you’re renting while paying towards actually buying your dream home!
Now, assuming that your lease term was for two years and that those two years have passed, it’s time to buy the home! Depending on your agreement, you’ll subtract either your option fee or the total rent credits from the purchase price. If you opted for the rental credits, then you’ll have paid $7,200 towards the house at the end of two years ($300/month times 24 months).
The Advantages Of Rent-To-Own Homes
If you’ve gotten to this point in the article, then you hopefully already see that the biggest benefit of a rent-to-own home is the ability to buy a house you love while you’re living in it and saving up money to purchase it later.
A rent-to-own system of ownership is like buying a property on an installment basis. You get some extra time to come up with the complete payment. In the meantime, however, you’re not wasting money paying rent for a house you’ll never actually own.
The Disadvantages Of Rent-To-Own Homes
During the lease period, you'll be responsible for all maintenance and repairs. You no longer want to buy the house after the agreed time? You won't be getting back any money you spent on repairs and maintenance. That definitely sucks.
Also, the extra money you paid on the rent that was meant to serve as an installment for a down payment will not be refunded if you decide to walk away.
So, Are Rent-To-Own Homes A Good Investment or Not?
At the end of the day, the answer to that question comes down to your specific financial situation. If you’re set on building wealth through homeownership but don’t have the credit score or savings to buy a house right now, a rent-to-own home could be a great option for you.
Whatever happens, the house becomes yours after you purchase it at the end of the lease period. Then, you can do whatever you want with it (including selling it at a higher price to make money).
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