The Pitfalls of Rent-to-Own Homes

May 7th 2016

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Rent-to-own homes may seem like a mutually beneficial arrangement for both buyers and sellers. Prospective homeowners get the home they want without a down payment or mortgage approval, while the property owner receives an immediate steady stream of income. Unfortunately, many rent-to-own contracts, also known as lease agreements, are never fulfilled. Convoluted sales contracts, high purchase prices and other pitfalls cause home buyers to lose their equity and the house they love. For this reason, it's essential that buyers considering lease agreements thoroughly understand the disadvantages of this type of arrangement.

Rent-to-Own Homes Are More Costly

Many buyers are lured into lease agreements because they are perceived as an inexpensive way to enter the housing market. Buyers can obtain a rent-to-own contract without a down payment, but they will need to pay an option fee, which acts a partial non-refundable down payment, before signing. They must also pay a monthly rental premium, in addition to their monthly rent. The rental premium is added to the option fee to build a down payment during the length of the contract, but these fees aren't refundable. Also, most rent-to-own homes cost more than traditionally-sold homes due to the seller's added risk.

Mortgages Can Be Difficult to Obtain

Lease agreements attract many buyers with fair-to-poor credit. While they may qualify for rent-to-own housing, they may not qualify for a mortgage at the end of their contract. Ideally, a lease agreement allows the potential buyer to demonstrate creditworthiness while building a greater nest egg. However, some buyers may have credit problems that cannot be fixed with one or two years of financial responsibility. If the buyer cannot qualify for a mortgage at the end of the lease period, the option fee and rental premiums are forfeited.

Lease Agreements Offer Little Flexibility

Even a seemingly minor violation of the lease agreement, like a single late rent payment or delayed outdoor maintenance, can allow the seller to evict the buyer without refunding the rental premiums and option fee. While most buyers may intend to follow the agreement, a medical emergency, unemployment or other financial difficulty could cause the buyer to lose all of the equity without recourse.

The Real Estate Market Could Plummet

Lease agreements specify the sale price of the house, but there's no guarantee that the home will retain its stated value during the length of the contract. When the lease agreement ends, the prospective buyer may find that the house is overpriced. If the buyer declines to purchase the property, the equity is forfeited. Buyers who still want to purchase the property may find it impossible to find a mortgage company willing to lend above the current market value of the house.

A Rent-to-Own Agreement Does Not Extend to Third Parties

If the seller loses a property due to foreclosure from a mortgage company or a tax lien, the buyer may have little recourse. The rent-to-own contract does not protect the buyer from third parties who may be able to claim the property. The lease agreement should force the seller to refund any equity and the option fee, but the buyer will most likely lose the option to buy the property. Buyers who have made any improvements to the property should not expect any compensation for their sweat equity or material costs. 

When compared to the potential risks, rent-to-own homes offer few concrete advantages. Buyers who would like to purchase their own home should consider alternative methods to finance their dream home. If the buyer has good credit, but can't afford a down payment, government programs may be able to help. Saving money for a down payment and placing it in an interest-bearing account for a few years may delay home buying but is also substantially less risky.

Buyers determined to sign a lease agreement should hire an independent real estate attorney to protect their interests. A lawyer will be able to explain the lease agreement in detail and negotiate safeguards to protect the buyer and avoid common pitfalls. Prospective buyers should also talk to mortgage lenders to determine if they'll be able to qualify for a mortgage at the end of their rent-to-own contract.


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