Today, we aren’t talking about a specific project, INSTEAD we are talking about something I have been meaning to look into for months now- RENT-TO-OWN programs. I basically knew NOTHING about them. So, I did some SERIOUS research. Let’s talk about that.
So, as we do, let’s talk Real Estate, let’s talk RENT-TO-OWN PROGRAMS…
FIRST OF ALL, WHAT IS A RENT-TO-OWN PROGRAM?
A rent-to-own program is the event in which a tenant and a landlord sign a rent-to-own agreement (I am sure you read that and thought duh! continue on please…) This is a typical rental agreement with an option to purchase the property on a specific date for a pre-determined price.
HOW DO THEY WORK?
They are pretty much structured the same way a rental agreement is structured, except that, at the end of a specific period of time, the tenant may have the right to purchase the property for a pre-determined price. With these agreements, the rent is typically higher than market, and a portion of the monthly rent payments will act as a credit towards the future purchase of the home. This allows the renter to build equity in the home before they even own it! These rent-to-own programs are made up of two agreements;
The rental agreement is structured fairly similarly to your standard rental agreement with a few caveats…
Rent is typically higher than market, with a specified percentage being put into an escrow account to help the renter build-up equity towards the future purchase of the home. This helps the renter save money over time to put towards a down payment, and helps the landlord feel more secure that the renter will go through with the purchase at the end of the option period. For example, if the rent is currently $1,000/month, the rent may increase to $1,300 with that extra $300 going into an escrow account as a credit towards the future purchase of the home. In exchange for this credit, the landlord may structure the lease such that, if the tenant is late paying rent on any given month, the renter may lose that month’s credit.
The maintenance and upkeep responsibilities of the home will typically shift from the landlord (landlords are responsible in standard rental agreements) to the renter. That being said, the landlord is still responsible for major repairs and ensuring the home is habitable!
Despite the fact that the renter does have the option to purchase the home, there are still rules they will need to follow as a tenant. They can still be evicted, if necessary, and will ultimately forfeit any credits and fees they had already paid.
Option to purchase
This gives the renter the option to purchase a home within a specified time frame, for a pre-determined price (either a fixed price, or a price based on the appraisal on a future date).
In order to have this option to purchase the property, and essentially hold it off the market, the tenant/buyer will pay the landlord an option fee. An option fee is typically anywhere from 2.5%-7.0% of the future purchase price. The option fee will act as a credit towards the home in the event that the tenant/buyer does go through with the purchase of the home. In the event the tenant/buyer does NOT exercise the purchase option, they lose this deposit.
An option period usually lasts anywhere from 1-5 years. Depending on the specifications of the contract, the tenant/buyer may have the right to purchase the home at any point during this option period, OR on a specified date.
WHO DO THESE PROGRAMS BENEFIT?
For the tenant / buyer…
The tenant benefits in that they get a chance to own a home that they may not have ever had the opportunity to purchase. This is great for tenants/buyers who may not be able to obtain a traditional mortgage at the moment, whether it be for lack of cash or credit issues. This option period will give them time to build up cash (equity) towards the purchase or help improve their credit score.
The price is typically pre-determined at the time of origination. So, in the event the market goes up, the buyer may get a steal!
Finally, the tenant/buyer does NOT actually have to purchase the home. The tenant/buyer make opt to walk away in the event their financial situation changes, market value decreases, they decide they do not want to plant roots in this neighborhood, etc.! While the tenant may pay a hefty fee to have the option to purchase the property, they are not legally obligated to purchase the home.
For the landlord / seller… you have a few different benefits! This program is particularly advantageous for landlords who currently have a negative cashflow.
If you, as the seller, had been having trouble selling the property on the market, you may now have the opportunity to sell the property through this non-traditional route.
During the option period, the seller would have a long-term, reliable tenant who now has a stake in the upkeep of the property.
The landlord can typically charge a higher rent, and propose a higher sales price because the tenant is able to build equity from the get go.
In the event the tenant/buyer does exercise the option to purchase, the seller is able to sell the home without paying a commission. This is essentially a “For Sale by Owner” transaction, saving the seller 3%-6% in commission fees.
Furthermore, in the event that the tenant/buyer decides NOT to exercise the option to buy, you as the current owner/landlord, will retain the option fees.
WHAT ARE SOME CONSIDERATIONS?
For the tenant / buyer…
While the option agreement does give the tenant first dibs on the property and allows them to save up towards the purchase of the property, it does not guarantee that they will be able to obtain a mortgage at a future date. In the event the tenant was unable to obtain a mortgage, they would lose all of the option fees and credit they had put towards the home. In order to prevent this, the tenant should meet with a mortgage lender before they sign the rent-to-own agreement, and make sure they fully understand what will be needed to obtain financing.
Just like a pre-determined price can be a blessing, it can also be a curse! In the event the market drops, the tenant/buyer could be stuck paying an inflated price just so they can salvage the money they had put towards the purchase of the home thus far (option fees + higher rent).
The rental agreements in rent-to-own programs are actually structured such that the tenant might be responsible for upkeep and maintenance (aside from large expenditures), whereas this is typically the landlord’s responsibility in a standard rental agreement.
The tenant should ensure they will be able to abide by the full rental agreement, including paying rent on time. In the event the rent is late, the landlord may keep the excess rent for that month, whereas that would have typically gone towards the buyer credit on the home. Furthermore, if the tenant does not follow the agreement, they can be evicted, and will lose out on the fees paid thus far.
In the event the landlord loses the home due to foreclosure, the tenant will most likely lose their option to purchase, as well as all of the money they had invested in the home thus far.
In the event that the renter does not choose to exercise the right to purchase the home, the fees they paid for the option may not be refundable.
For the landlord / seller…
The landlord is contractually obligated to sell the property at the contracted price to the contracted buyer. In the event a different buyer were to come knocking on the door and offer a higher purchase price, the current owner / landlord would have to refuse the offer, and lose out on earning that excess cash.
It is also important that the landlord/seller ensures that the contract abides by local and state laws. In the event that the original contract is missing specific wording, or specific clauses, the contract may actually be invalid. In the event the contract is invalid, and the buyer chooses not to exercise their purchase option, you may have to actually reimburse the option fees to the buyer… NOW RUNNING to reading up on Binghamton and Philadelphia local laws!
To be honest, I have read some serious mixed views on these programs. However, under the right circumstances – I think these programs sound awesome! It makes home ownership that much more attainable! What do you guys think? Would you consider a rent to own program?!
Feel free to comment on the blog post HERE and let us know what YOU think!
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