First-Time Homebuyers: Time to Consider Rent-to-Own?

Finding the Right Mortgage, Mortgages
You can trust that we maintain strict editorial integrity in our writing and assessments; however, we receive compensation when you click on links to products from our partners and get approved. Here's how we make money.
First-Time Homebuyers: Time to Consider Rent-to-Own?

A rent-to-own home, or lease-purchase agreement, might seem like the perfect solution for the can’t-quite-get-there homebuyer. Maybe your credit needs a few touch-ups, or you don’t have a down payment in the bank yet. A lease-purchase agreement can get you in a home of your own while you sort out the buying details, right?

Yes — but nobody says it will be easy.

First, it’s not a financial slam dunk. You’ll likely pay a lot more upfront, and on top of your rent, you’ll pay a rent premium fee — an additional amount that’s applied to the potential purchase.

You’ll still have to save for a down payment while also paying off bills and polishing your credit score to qualify to buy the house before the contract ends. Perhaps worst of all, those rent premium fees you’ve been building up as earnest money for the purchase may be forfeited if you ultimately can’t clear all the hurdles to buy.

“Lease-purchase for real estate is not as simple as the neighborhood rent-to-own store, so do not assume they work the same,” says Glenn S. Phillips, CEO of Lake Homes Realty in Pelham, Alabama. Phillips has worked with rent-to-own home agreements as a landlord as well as with his multistate real estate firm. “Many people, including some licensed agents, don’t realize the legal ‘gotchas’ of poorly designed lease-purchase agreements. This can lead to loss of money, time — and even extensive legal fees.”

 

How a lease-purchase or rent-to-own home agreement works

Of course, no real estate agreement — rent-to-own or straight-out purchase — is a simple matter. But lease purchases can be particularly difficult to navigate.

Some agreements are structured as lease options — you rent the home and have a nonbinding option to buy it eventually. A lease-purchase home agreement is more definitive, with a set purchase price and a limited time frame. With both, make sure you understand:

  • You’ll likely pay a substantial deposit — in addition to the usual upfront costs such as a pet deposit — and have a monthly lease payment (the rent) with an additional fee (the rent premium that builds up as earnest money).
  • Lease payments may or may not fully apply to the purchase.
  • The rental premium payments may not be refundable if you don’t end up buying. In most instances, contracts are structured so that if the purchase does not take place, the owner of the property keeps all payments.
  • State laws vary, so you’ll need a real estate attorney on your side.

“An alternate approach to a single lease-purchase agreement is to use three contracts,” Phillips adds. “One is a standard real estate purchase agreement that has a close date that may be months or years away. The second is a standard rental agreement for the time frame prior to purchase. And the third contract is a purchase option agreement that indicates under exactly what conditions the buyer is given credit for lease payments at the time of purchase.”

In this scenario, the purchase option may include a requirement for the buyer to pay the owner some amount of money — a deposit — that is nonrefundable. In exchange, the owner removes the home from the market.

“This seems complicated but in reality can be a much cleaner legal approach and, once understood, avoid confusion for all parties,” Phillips says.

Can rent-to-own be a path to homeownership?

Rent-to-own agreements can’t remove all of the barriers to homeownership. For example, if the buyer can’t afford a minimum down payment — or if the monthly rental payments are a financial stretch — it’s doubtful he or she will ever make it to the closing table for a purchase.

“Don’t start down a path that is doomed from the start,” Phillips advises.

Lola Audu of Comstock, Michigan, has been a real estate broker for more than 20 years and has experience with leases that contain purchase options. And from what she’s seen, the results have not been good.

“In my experience, they have never panned out to a purchase,” Audu says. “Buyers who can’t finance a purchase are often not the best candidates for homeownership. Credit and down payment issues are fundamental, structural problems. They need to be corrected prior to purchasing a home rather than trying to purchase through a lease and work on financing issues.”

She says lease-purchase arrangements often become “glorified rental experiences.”

“When the initial excitement of being in a home wears off, the buyer no longer has the incentive to continue to do what is necessary to make the necessary corrections to obtain financing,” Audu says.

Phillips of Lake Homes agrees: “Our experience is that lease-to-own rarely becomes a purchase. If it looks like a shortcut to homeownership, it is not.”

Although, he says, never say never: “I do have one property right now where I have a very long-term renter who I believe will convert to a purchase. This is an exception, and we did not start out with anything but a simple lease to begin with, then discussed a possible purchase later.”

Some companies want to reinvent rent-to-own homeownership

So the rent-to-own route looks to be a winding road full of potholes. Seems like it’s nearly impossible to get from here (renting) to there (owning). But at least a couple of companies want to change the lease-purchase landscape.

Imagine finding a home listed for sale in your market — one you really love — and having someone buy it and lease it back to you with an option to purchase. That’s what Home Partners of America does.

The process starts with an initial application and a nonrefundable $75 fee. If your prequalification application is approved, you submit a full application, which involves pulling a credit report. Then Home Partners tells you the maximum monthly rent you qualify for.

From there, you contact a real estate agent and find a home you’re interested in, and Home Partners negotiates a purchase. The company pays cash, which usually facilitates a quick transfer of ownership. Then you sign a one-year lease with Home Partners, as well as a right-to-purchase agreement detailing the price you’ll pay for the house if you exercise your option to buy. You’ll also pay a deposit, usually amounting to two months’ rent.

You have the option to buy the home at the pre-determined price any time within the next three to five years but are only committed to lease the home for one year.

The company currently serves residents in 34 cities in 18 states, including California, Texas, Colorado and Florida. It claims to have bought $1 billion of real estate to put more than 9,000 people (and 2,500 pets!) into “lease with the right to purchase” homes.

HomeLPC is another rent-to-own startup, though it currently offers its program only in California and Texas. But the firm aims to serve 20 states by the end of 2016.

Making a move with a purchase-option agreement

Maybe a purchase-option agreement can eliminate a couple of moving-truck loads on the road to homeownership. It’s an appealing prospect: Move into a home now, work out the wrinkles so that you can qualify to buy and ultimately close the deal without packing another box.

It might not be easy, but finding a way to crack the homeownership nut might make it worth all the effort.

More from NerdWallet:
How much house can I really afford?
Compare mortgage rates
Find a mortgage broker

Hal Bundrick is a staff writer at NerdWallet, a personal finance website. Email: hal@nerdwallet.com. Twitter: @halmbundrick


Image via iStock.