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How this works
Rent-to-own is sometimes called lease-to-own. But they are very similar. The way this works is that you pay the current owner a specific amount of money each month as rent. Then, at the end of a set period of time, you would have the option to buy the house. This set period is generally three years. During those years, some percentage of the rent you pay each month will go towards a down payment so that you could eventually buy the house.
It must be very clear
If you choose to rent-to-own, you need to make sure that the contract is very clear. It needs to spell out what you will pay for the house and the rent you'll be charged. Both of these amounts can be negotiated just as you would negotiate a normal sale. It's important that both of you remember that once you sign the agreement the selling price of the house is locked in until the end of the rental term. It doesn't matter whether housing prices fall or rise during that. The price you agreed on initially will be the final price.
You will also pay a rent premium as well as an additional fee. This is called an option fee and will be a specified amount. If you buy the house at the end of the three years (or whatever number of years the contract called for), this fee becomes a portion of your down payment. If you don't buy the house, the seller gets to keep the fee. The rent premium you will be required to pay will be somewhat above the rent typical for that type of house with some portion of it going towards an eventual down payment.
Here's an example of how this works. Let's suppose the house is worth $150,000 and it would typically rent for $1000 a month. If you were renting to own, you might pay $1200 a month and receive in return a $200 credit each month. Let’s suppose the option fee was $5000. If it was a three-year lease, you would earn $7200 in rent credits. If you add these credits to the option fee, you would have amassed $12,200 that could be used as your down payment.
A viable alternative
Rent-to-own can be a good option if you have a low credit score or not enough money saved for a down payment on a house. It can also be good for the seller who is trying to relieve himself or herself of the old house and earn some money whether or not it sells once the lease ends.
The pros and cons
If you see rent-to-own as a possible option, it's important that you understand both the pros and cons. One of the biggest benefits to this is that it gives you time to repair your credit history and build income as you rent. Second, if the house developed some serious problems, you could just walk away. Of course, you would lose your rent credit money and option fee.
Third, there is the upfront option fee. This is generally a percentage of the selling price of the house. As you saw in our example it’s usually thousands of dollars. While you will eventually be able to use this money as a down payment, it can be tough to save up thousands of dollars.
You could lose that month’s rent credit
If you're just a day late in paying your month’s rent, it could void your rent credit for that month. And finally, if your seller fails to pay on the mortgage, the mortgage company could foreclose on the house and you would be forced to move out.