Last Updated on July 13, 2021 by Maggie Looker
Home ownership is still a major part of the American dream for most people, and many can’t wait for the day when they stop renting and finally own their own home. But making that transition from renting to owning can be difficult financially, which is why some people take it quite literally, choosing to live in a rent-to-own home.
A rent-to-own home offers a unique opportunity for many prospective home buyers. But that doesn’t always mean it’s a good idea. Rent-to-own agreements come with a lot of risk for both renters and sellers. Here’s a look at how rent-to-own homes work and why you may want to consider other options.
How Do Rent-to-Own Homes Work?
A rent-to-own agreement is a contract between a homeowner and a renter where the owner agrees to sell the home at a fixed price sometime in the near future. In the meantime, the renter will rent and live in the home, as well as pay a little extra each month that can be used toward the future purchase of the home.
For example, a homeowner may agree to sell their home for $200,000 three years from now. During those three years, the renter will pay $1,500 in rent, plus an extra $500 monthly toward the purchase.
This arrangement allows renters who may not have enough for a full down payment to start working toward home ownership a little at a time. However, the nature of these agreements can leave both renters and sellers open to significant risk.
Limited Number of Rent-to-Own Homes
The first problem with rent-to-own homes is simply the fact that there are so few options out there. Most renters never seriously consider the arrangement, and if home owners are going to sell, they usually want to do it quickly. As a result, there’s simply not a large market for rent-to-own homes. Fewer options mean you may be forced into a situation and a home you’re not completely in love with. If you don’t find a rent-to-own home that you love, you may be better off pursuing other options.
Higher Monthly Payments
Rent-to-own agreements almost always result in higher monthly payments because you’re not only paying to rent the home, but also putting money toward the future purchase price. Following the example we gave above, you could see your monthly housing expense increase by hundreds of dollars every month.
One could argue that you’d be paying rent anyway, and at least with a rent-to-own home, you’re also building toward your future. But the fact is that you’re not actually building equity because you don’t own the home. Plus, you could be saving that same amount of extra money each month in a savings account for example. This would keep your housing options open, rather than tying yourself to one specific home.
Future Financing Risks
Rent-to-own home agreements are based on the idea that you pay a little toward the home while you rent, then get a loan to pay for the rest. But getting a mortgage loan isn’t as simple as it sounds. Lenders have lots of requirements that aren’t always easy to meet. If you’re unable to secure financing in a timely manner, you could lose the right to purchase the home. All of your time and investment will be for nothing.
Home Might Lose Market Value
When a renter and homeowner enter into a rent-to-own agreement, they decide on the final sales price of the home. This is put in a contract, and cannot be changed unless both parties agree to adjust the price. This means that if the home gains value while renting, it’s a win for you, the buyer, because you’re getting a home for lower than it’s value. However, if the value of the home decreases over time, the renter stands to lose money.
Real estate markets are constantly changing, and as homes age, new problems can appear that detract from the home’s value. By agreeing to a price now that may not reflect the true value of the home when you finally purchase it, you leave yourself open to significant risk.
Loss of Option Fee
At the beginning of the rent-to-own agreement, the renter will typically pay the homeowner an option fee, or option premium. This is generally equal to 5% of the agreed-upon sales price. This acts like a mini-down payment, giving the renter the option to buy the home at a later date.
However, if you decide not to buy the home, you could end up losing all of that fee. How this plays out depends on the exact stipulations outlined in your rent-to-own agreement. But, it’s worth considering how comfortable you are spending that much money just to have the option to buy a home.
Deal Falls Through
No real estate transaction is complete until all the paperwork has been signed, closing is complete, and funds and title have been transferred.
Any number of things can cause a deal to fall through, even if all parties are acting in good faith. There could be problems with your financing or credit, issues with the owner’s right to title, property line disputes with neighbors, or your contract could have been poorly written in the first place. By committing to something so far in advance, you risk losing time and money.
Homes for Heroes Specialists Can Help and Save You Money
If you want to make the transition from renter to homeowner but aren’t sure about your options, Homes for Heroes is here to help.
If you work in one of our hero professions — military, firefighter or EMS, law enforcement, teacher, or healthcare professional — simply register online to get more information. You’ll be matched with a local real estate specialist who is dedicated to helping heroes achieve their real estate dreams.
They’ll be able to offer advice on your particular situation and put you on the right path to home ownership.
Ready to stop renting and start owning? Register with Homes for Heroes today and you’ll save an average of $2,400 when you buy a home through our program.