As a renter, you've heard the old gripe "you're throwing your money away" more than once. Maybe you've even made the comment yourself. But if you haven't saved enough for a down payment and you aren't eligible for a mortgage, you don't get much say in how you distribute your housing budget—unless you find a unique opportunity in which you can rent now with the option to buy later.
Although they're a small slice of the rental population, these rent-to-own arrangements can be found. Maybe you're a long-term tenant who's already established a great relationship with a landlord who wants to sell. Maybe you found someone who may have purchased an additional property cheaply as a foreclosure or inherited a property that he or she no longer can afford. Or maybe you found a local condo development, like the Riverview Club in Yonkers, N.Y., which applies six months of rent to the eventual purchase price of a unit.
In a standard rent-to-own agreement, you still retain most of the rights of a renter, including the right to ask your landlord for repairs as well as the right to privacy. The option-to-own agreement is an additional contract that gives you the opportunity to buy the house in the future. The comprehensive and often complicated contract includes:
- An upfront fee that acts as an incentive to the landlord to keep his or her promise to sell you the property.
- The percentage of your rent that will be applied to the down payment.
- The length of the contract, including the exact date and how you, the renter, will notify the landlord if you wish to buy the property.
- The selling price that you and the landlord agreed upon.
Janet Portman, an attorney and managing editor at NOLO, a publisher of do-it-yourself legal books and software in Berkeley, Calif., and author of "Every Tenant's Legal Guide," believes rent-to-own agreements are risky for both sides, especially when it comes to settling on the final price of the property.
In a standard rent-to-own agreement, you still retain most of the rights of a renter. "You can't say 'fair market value'—everyone will argue. The whole deal will fall apart," Portman says. "Everyone's taking a guess at what it will be worth [at a future date]."
And no one, not even an economist, knows what the price of a house should be two years before it goes on the market. Settling on a price is a gamble for both parties.
"You must be absolutely sure you want it and be willing to take the risk that you may pay more," Portman says.
However, there are benefits to both the buyer and the seller in rent-to-buy opportunities, and most of them are personal. Renters simply may have fallen in love with a house and don't want to move again. Or they really may want to send their kids to a nearby school or may have gotten used to the short commute to work.
Besides avoiding a 6% commission to a broker, the landlord may know that the buyer will care for the house more than a typical renter. Minimal repairs and upgrades are much more likely to happen when a renter knows they will own the property someday. Also, the buyer is likely to pay the rent on time because option-to-own agreements often allow the landlord to revoke the contract if there's a missed rent payment, according to Portman.
For a buyer, it's not just about finding a great property. It's about finding a great landlord, too—one with good credit and a good reason to sell, not one who will secretly foreclose on the property, then take your money and run. Portman warns that you should participate in a rent-to-own agreement "only when you know, trust, and like the seller, and you can count on issues being resolved amicably without having to get additional lawyers involved." If the landlord and tenant have done business together for years, there's more of an incentive for everyone "to do what is necessary to make the deal happen," according to Portman.
Rick Martinez, a 35-year-old business owner who now lives in Maplewood, N.J., successfully purchased a rent-to-own condominium years ago in Hoboken, N.J. He discovered the opportunity online at a real estate agent's website while apartment-hunting. While he was nervous at first, the whole process was fairly simple, he says.
"I was fortunate enough to lock in the market price when I started to rent and then the market value of homes went skyrocketing," Martinez says. "When my rent period was over, it was a no-brainer. I had to buy my condo."
In addition to settling upon a fair price one year in advance, about $10,000 of Martinez's rent was applied to his down payment. He owned the property for five years before selling it to fund his new business.
To ensure a smooth relationship and a successful contract, Portman highly encourages renters to work with a real estate attorney in their state who's very familiar with the rent-to-own process and the tax consequences. Because option-to-buy contracts are often more complex than home-sale contracts, potential buyers must work closely with a lawyer, Portman says.
In some states, option-to-buy contracts trigger disclosures—the same ones a seller makes when selling a house—such as problems with drainage in the backyard or lead-paint issues. Even if your state doesn't require release of these details, as a buyer you must insist on discussing these issues before entering into the contract, Portman warns.
While applying rent money to a down payment is a great way to build your savings, you'll still need to qualify for a mortgage and take on additional costs associated with home ownership beyond mortgage payments, such as repairs and taxes, when it comes time to buy the property. Talk to a mortgage specialist at your credit union to devise a plan that will prepare you for all the responsibilities of home ownership.
If you're not yet ready, Portman reminds potential buyers that many rent-to-own opportunities don't have to be rushed—they're a completely separate agreement from your lease.
"You can always ask for a deal after you've been a tenant for a while. It doesn't have to happen at the moment you sign the lease," Portman says.