- Why Rent-to-Own Can Be a Bad Option for Some Buyers
- 1. They Have a High Overall Cost
- 2. There are Non-Refundable Option Fees
- 3. There is a Chance That You Lose Your Investment
- 4. You Might Have to Buy a House You Can’t Afford
- 5. You Have Limited Control Over the Property
- 6. There is a High Potential for Scams and Unfavorable Terms
- 7. You Might Fall Out of Love With the House
- 8. Missed Payments Could Ruin the Deal
- 9. You Could Lock in Bad Rates
- Who are rent-to-own contracts good for?
- Alternatives to a Rent-to-Own Agreement
- Know Your Options Before Signing a Rent-to-Own Contract
Why Rent-to-Own is Bad for Buyers and What to Do Instead
If you are trying to buy a house but don’t have a large downpayment, you might consider entering into a rent-to-own agreement. With this option, you will rent a property for a year, and a portion of your rent check will go toward a down payment. After the rental period ends, you will buy the house.
At first, the concept of a rent-to-own property might seem appealing. You can finally move into your dream home and work toward homeownership, even if you can’t buy just yet. However, these contracts aren’t always beneficial to the renter. You could lose more money by opting for a rent-to-own home instead of simply renting for a year or buying right now.
Here’s why rent-to-own is bad for some buyers, along with alternative options to consider.
Why Rent-to-Own Can Be a Bad Option for Some Buyers
Before you agree to a rent-to-own agreement, make sure that this is the best possible financial decision. Compare your rent-to-own options against standard renting and buying right now.
Here are a few ways that rent-to-own contracts cause buyers to lose money and limit their options.
1. They Have a High Overall Cost
The first reason to rethink rent-to-own homes is that you will pay more each month for your housing. The median rent in the United States is $1,845. If you enter into a rent-to-own agreement, you might agree to pay $2,100 per month as part of your down payment on the house.
Through the agreement, $250 of your monthly rent would go toward your down payment. While this is a reasonable increase, you aren’t saving that much. At the end of the year, you will only have $3,000 saved for your down payment.
There are other ways to set aside that money. For example, you might decide to open a high-yield savings account. From there, you could deposit $250 each month and hold onto it yourself. This allows the money to grow as you accrue interest. This also provides more flexibility in case you need to use your money for an emergency. It’s easier to pull money from your nest egg than to get out of a rent-to-own agreement.
The median home value in the United States is $412,000 as of Fall 2023. A minimum down payment for an FHA loan is 3.5% or $14,420. Calculate how long it will take to hit your down payment goals and whether a rent-to-own agreement will actually help you reach them.
2. There are Non-Refundable Option Fees
A common aspect of the rent-to-own agreement is the option fee. This is a non-refundable fee that the buyer gives to the seller once they enter into the lease-purchase agreement. The option fee is negotiable but usually falls between one percent and five percent of the purchase price.
This fee alone with one of the biggest reasons to reconsider rent-to-own agreements. If you are trying to save for a down payment, you could lose a significant amount of money on this non-refundable deposit. You might be better off renting another apartment or home and applying those fees to a larger down payment.
3. There is a Chance That You Lose Your Investment
Rent-to-own contracts are often recommended to people who need to improve their credit scores and increase their down payment amounts before they can buy. They are seen as tools for people who are eager to be homeowners but aren’t financially able yet. However, there is no guarantee that you will be ready to buy the house once the lease agreement is up.
Over a year, you might not save as much as you would like or the bank might want you to improve your credit score even more. Life emergencies happen and you might need to use your savings to replace your vehicle after an accident or pay medical bills.
If you are not able to buy the house at the end of your lease-purchase agreement, you could lose the money you gave the homeowner for the down payment and will have to start your home search fresh.
4. You Might Have to Buy a House You Can’t Afford
When you sign a rent-to-own agreement, you will either enter into a lease-option or lease-purchase contract. A lease-option clause gives you the right to buy the property for the negotiated purchase price at the end of the rental period and is completely optional. You can walk away from the property if you need to or no longer want the house.
However, a lease-purchase clause requires you to buy the property. At the end of the period, the homeowner will expect you to move forward with the purchase agreement. There is less wiggle room for getting out of this contract, which means you could end up owning a house you can’t afford.
For example, if you have a dual-income household with your partner but one of you gets laid off, you will lose a large portion of your buying power. You might not qualify for a mortgage with a single income and would need to move out of the house. It would be easier to end the agreement with a lease option than a lease-purchase contract.
5. You Have Limited Control Over the Property
During the rental period, you have the same rights and privileges as tenants. This means the homeowner is still responsible for making repairs and keeping up with basic maintenance. However, this also means you have less control over the property.
You will not be able to make improvements or modifications to the home until you own it. Depending on the lease agreement, you might not even be able to repaint the walls until the house is yours.
As a renter, you are entirely dependent on the homeowner to keep up with repairs. If the homeowner doesn’t respond quickly or thoroughly fix something that is broken, you could be stuck in an uncomfortable housing situation.
6. There is a High Potential for Scams and Unfavorable Terms
Not all rent-to-own agreements are ethical and some are downright illegal. First, carefully read any contract you are given to make sure that you aren’t paying excessive fees and overly high rates. A high option fee and high monthly rent expectation could be a major warning sign that the homeowner isn’t interested in helping you prepare to buy the property. The owner might say they are going to sell you the house at the end of the lease agreement and then decide not to.
Other rent-to-own options are real estate scams. This occurs when someone who doesn’t own the house tries to rent it to others. They will take the option fee and then disappear once you try to move in. Always confirm that the person you are working with actually owns the home – you can check local property records to make sure.
You can also avoid rent-to-own scams and grifters by working with a trusted real estate agent or real estate attorney. They can identify clauses that are out of the ordinary or pick up on scams that you might not be familiar with.
7. You Might Fall Out of Love With the House
Moving into a house is new and exciting, but the longer you live there, the more you will discover its flaws. Some issues can be fixed (like old appliances and poor landscaping) but other problems are more serious. You could find that the bathroom is too small or the noise from the highway is too loud.
This is another reason why you should opt for a lease-option contract instead of a lease-purchase agreement. If you don’t like the home anymore, you can just walk away.
While a rent-to-own deal could help you test out a house before moving in, the financial risks are too high. Instead, schedule multiple showings to look at a house in detail before making an offer to buy it.
8. Missed Payments Could Ruin the Deal
If you encounter financial hardships during the year, you could risk losing the house and ending the rent-to-own agreement. The homeowner has to be willing to accept late payments and allow you to keep living there. While there are always risks that come with missing housing payments, the stakes are higher when you are trying to buy a house as well.
It might be better to put the option fee in a savings account or other secure location and add money to it each month to grow your down payment. If something goes wrong, you will have an emergency fund you can tap into.
9. You Could Lock in Bad Rates
When you agree to a rent-to-own plan, you will lock in the purchase price of the home. The extra money the homeowner collects in your rent payments goes toward the purchase price. However, real estate markets fluctuate. A favorable price right now could be unfavorable in a year. The value of the home might decrease, which means you will overpay for the property.
When you buy a home, you will need to get an appraisal to understand its value. Your mortgage lenders will look at the appraisal to make sure you aren’t overpaying. With a rent-to-own agreement, you might be overpaying based on your contract and the market. This could complicate your loan approval.
A lot can happen in a year. A rent-to-own agreement forces you to assume that you will be financially stable for the next 12 months and the real estate markets will stay in your favor. That’s a lot to hope for.
Who are rent-to-own contracts good for?
Rent-to-own deals come with several risks, but these options are still beneficial to some buyers. If you find a homeowner who is willing to enter into one of these agreements and acts ethically, they can help you save money and improve your financial standing over the year. Here are a few times when you might benefit from signing a rent-to-own contract.
- You have short-term credit issues: You can improve your credit score over a year by paying down your bad debt and building a positive payment history. This could help you qualify for a mortgage or get a better interest rate.
- You need time to save for a down payment: a rent-to-own agreement is designed to help buyers save. At the end of the year, you should have a decent down payment available to purchase the home.
- You want to lock in a good purchase price: Real estate markets can change quickly. By locking in a purchase price, you don’t have to worry about houses becoming unaffordable within a year.
- You find your dream home: it might be worth the risks and fees of a rent-to-own contract if you know that the house is perfect for your needs.
The concept of rent-to-own homes is sound. However, too many people try to take advantage of buyers in today’s market, which makes this option risky. If you choose this route, make sure you have a clear understanding of your contract and financial picture.
Alternatives to a Rent-to-Own Agreement
If the risks of looking for a rent-to-own home seem high, consider other options. There are multiple ways to realize your dream of becoming your homeowner without taking a risk. Here are a few options.
- See if you qualify for a mortgage: some lenders specialize in helping buyers who have small down payments. A lender can guide you through the application process or set goals to prepare to buy in the future.
- Find someone to co-sign: see if a family member will co-sign your mortgage loan, reducing the risk to the bank. This could encourage more lenders to work with you.
- Continue to rent for a year: set a timeline for when you want to buy a house. Keep setting aside money for a down payment and improving your credit score until the time is right.
There are always multiple options when it comes to homeownership. Know which one is best for you before agreeing to a rent-to-own arrangement.
Know Your Options Before Signing a Rent-to-Own Contract
While you might be able to find an ethical rent-to-own deal that helps you grow your down payment, you are still delaying homeownership. You will still need to pay rent and hope that the homeowner is acting fairly towards you. For many buyers, this is too much of a risk to even consider.
Take the first steps toward the purchase of a home and talk to a real estate agent today. A trusted Realtor can look at your finances and provide honest advice about whether you can afford to buy. Homeownership might be closer than you think.
To find an agent in your area, turn to the professionals at FastExpert. Read through various Realtor profiles and find agents that help first-time homebuyers and people with growing credit. Try our services today.