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How does Rent-to-own work?

Have you ever wondered why the real estate websites are full of rentals, but you can barely find a rent-to-own or lease option home? Have you also noticed that mortgage payments are more expensive than paying rent?

Believe it or not, most landlords actually loose or barely earn any money from their rentals these days. With the exception of those who bought their rentals long time ago, when housing was way cheaper. Why are they keeping their properties then?  Simple: they don’t want to give up on the appreciation, because real estate usually gains value over time.  

Rent to own, lease options or lease purchase, is a popular way to buy a property among people struggling to get financing from a traditional bank. As the name suggests, you basically need to find a landlord willing to sell you their property after some time,  but here is the key: you will sign a contract stating the conditions of that future sale today. You also need to sign a lease agreement, but you won’t have the typical restrictions you have in a regular rental. Of course the seller will want some money upfront to give you control of the house and lock in the price, but it will usually be way less than the bank would ask for.  This has several advantages for the buyer over a simple purchase and sale transaction, but especially  two are outstanding:

1. It will lock in the price of the house you put under contract, so you can keep the appreciation of the house, and the most important one:

2. Different than regular leasing, you can really make the house your home from day 1. Because you and the owner are committed to the transaction, they will usually allow you to make the decorations or improvements that you would do to your own. This will depend on the final agreement with the seller; but yes, you will usually be able to paint it, hang your frames, plant your garden, build a house in the tree…

Think about the house you are renting today, how much you would have in appreciation if you had locked the price 5 years ago? How would the house look today if you had had the freedom to remodel?

Let's see whether this is a good option for you with an example.

 

 

Imagine that you are interested in buying a house that you liked, the owner wants $400,000 for the house.

 

You go to your bank and they ask you for an $80,000 down payment, or a 620 minimum credit score. You only have $25,000 available and your credit score is closer to 500, so they reject your application even though you have a  stable job.

Then, one of the neighbors tells you that he is willing to sell his house to you. All he wants is $9,000 upfront to formalize the promise of you buying the house. This is called an option fee. He will sign a contract with you stating that in exchange for that money, he will take his house off the market and give you 5 years to buy the house, and will lock the price at $425,000 during those 5 years!

Plus, he will credit to your option fee $150 for every month that you pay your rent on time, and will give you the option to remodel and upgrade a couple of things in the house, given that you are going to buy it anyway.

Five years later,  you have saved $15,000 more, and your credit score is around 650, so you give the bank a second try. 

They are pleased to know that you already gave the homeowner a down payment of $18,000 ($9,000 option fee + $9,000 credit from monthly rent) so you have more than enough to get approved!

The bank orders an appraisal and turns out that the house is now appraised at $490,000. But no worries, you will still buy at $425,000 as per your contract, so you already have a good amount of equity!! The best part is that you don’t have to move again from the community where you have belonged for the last five years.

You can also see this video to learn more, or see our FAQs below

*All numbers and events in the above story are created for educational purposes and not guaranteed in any way. Better Home of Tennessee assumes no responsibility for financial decisions taken based on this or any other publication on this website.

Frequently Asked Questions

There is no interest rate, because the seller is not financing your purchase. The seller is giving you the option enjoy ownership of the house before you close. The owner may sometimes give you credit for every month that you pay the rent. This money is discounted from the purchase price when you exercise your option.

No, you will be renting the house, but you will have the freedom to remodel and exclusive right to buy the property during that period of time.

You have the right, not the obligation to buy the property. You can walk away if you wish, but you will not recover the option fee given to the seller. It is comparable to an earnest money in that sense.