Is Rent-To-Own An Affordable Way to Buy a Family Home?

Option Fee vs. Down Payment

On paper, rent to own seems like a dream come true. You can finally get your own home without the bank constantly chasing after you. However, most RTO buyers are not really getting a good deal.

With a traditional purchase, a buyer takes out a mortgage and pays a down payment that typically ranges from 5% to 25% of the total purchase price of the home. The median down payment averages 12% in the U.S. So, on a $200k property, the bank will expect the buyer to pay somewhere between $10,000 and $25,000 as a down payment. This can be offset by seller's credits and other discounts, but the buyer is also expected to pay for appraisal, title, and inspections, which can run well above $1,000.

An RTO agreement could minimize the need for such a large deposit, but most of these agreements have an Option Fee, which is a non-refundable payment that reserves the right to buy the property by a mutually agreed upon date. This fee usually is about 5% of the price of the home, but the seller has the discretion to lower it. On the same $200,000 house, though, a 5% fee is the equivalent of the lowest traditional down payment. Even more concerning is that the option fee is not secured, so there are two major risks:

1. You are handing over money to an individual instead of a registered lender.

If the landlord is a scammer or just simply irresponsible with their money, it could create costly disputes. Even with a signed contract, it can be expensive to fight a legal battle to resolve any issues that may arise.

2. When the rent-to-own term comes to an end, a tenant may be obliged to purchase the home, depending on the contract.

However, if the tenant decides they don't want to be an owner, then that option fee is forfeited.

Verify the title.

Failing to verify the title of the home is a common mistake that many RTO buyers make. With a traditional home purchase, buyers are protected by laws that ensure that the seller of the property is the legal owner of the home. They cannot list the property to the Metropolitan Regional Information Systems (MRIS) or Multiple Listing Service (MLS) if they cannot prove ownership and their right to sell. These assurances protect the buyer.

However, with an RTO agreement, those protections can easily be lost. A landlord doesn't need to show they're the legal owner of the property to execute a lease. Think about it: Property managers do this on behalf of their clients all the time. So, RTO disputes can happen when there are multiple owners of the property. Say, all parties agree to rent the home, so one person lawfully executes the lease. But, that one person doesn't have the right to sell the home without the permission of the other owners. Disputes and disagreements between owners could foil the best made RTO plans.

Because most RTO deals are one-on-one, buyers often don't involve real estate agents, lawyers, or title companies, whose job it is to have their back. These lapses can result in lost money and time, as well as sizable amounts of disappointment.

Mortgage now or mortgage later.

An RTO agreement doesn't mean avoiding a mortgage; it just means delaying it. A lease term could be used to improve credit scores and save for a down payment. However, there's no guarantee that a tenant will be able to secure a mortgage later.

A slight shift of 15 to 20 points in your credit score could spell mortgage approval or denial. Also, the APR might become too high to afford consistent monthly payments. If the buyer doesn't get approved or doesn't agree to the loan terms, the landlord is neither obliged to return the option fee nor to extend the lease.

4 Ways to Make Rent-to-Own Benefit the Buyer

If you're still willing to take the risk on the rent-to-own option, then be sure to consider these four factors before signing a contract.

Be realistic about your finances.

Work with a bank early on to understand what you would need to do to qualify for a mortgage when the lease term is up. Sometimes it is as simple as credit repair, but other times you'll need to get a new job with higher W2 income, pay back taxes, and show proof of funds in the bank. Use the lease term wisely.

Make sure the title is clear.

When you're entering the contract, do a title search and get title insurance. This way, you'll be sure that, legally, the home is in the name of the person you're buying it from. It would be devastating to have someone come knocking years later claiming to own your new home.

Ensure all seller costs are paid before you take ownership.

Before you get complete ownership of the home, make sure the mortgage, taxes, and other outstanding charges on the seller's side are paid. This can include back taxes, utilities, and even homeowner's association dues. To ensure you won't be responsible to pay the seller's leftover bills, get proof of payment in writing from these service providers.

Hire a professional.

Rent-to-own agreements are not as straightforward as they seem. These contracts are typically made to favor the seller, and sellers expect that buyers might be too vulnerable or naïve to catch clauses to their disadvantage. Be sure to hire a real estate agent and a lawyer, who can help review the agreement and negotiate terms that are realistic and fair.