Rent-to-own is a relatively recent trend in the residential housing market. The system can allow buyers with a less than stellar credit history purchase a home and can be a viable alternative for sellers who are wanting to move but who are having difficulty attracting buyers for a traditional sale.
How Rent-to-Own Works:
In a rent-to-own arrangement, the tenant/prospective buyer agrees to purchase the home at a future date, typically in two to three years. In lieu of a security deposit, the tenant pays a down payment, usually double the amount of the usual security deposit, that will be applied toward the purchase price if they decide to buy the home on or before the agreed date. The tenant also pays rent that is higher than the normal market price for the same home. In most cases, the amount over the market price acts as a credit that the tenant can apply toward down payment or closing costs if they choose to exercise their purchase option. If the tenant decides not to buy the house at the end of the contract period, they do not receive a refund.
Advantages of Rent-to-Own Agreements:
A rent-to-own transaction can allow the seller to secure a long-term renter and potential buyer who is more likely to care for the property than a standard tenant. The buyer benefits from locking in the sale price of the property in advance. Depending on fluctuations in the housing market, this can allow the buyer to purchase the property below market value. If the reverse is true and the property decreases in value, the tenant can simply walk away. If the buyer has a checkered credit history, the contract period can provide them with the opportunity that they need to rebuild their credit and to save more money toward the down payment.
Disadvantages of Rent-to-Own Agreements:
From the seller’s perspective, rent-to-own contracts are not a guarantee that the home will sell. A large number of tenants choose not to exercise the purchase option. The seller also cannot take advantage of any increase in property value during the contract period. For buyers, it is important to remember that life can change dramatically and unexpectedly during the contract period in terms of marital status, employment, and finances. A rent-to-own agreement only makes sense for buyers who are confident in their future plans since choosing not to purchase can mean the loss of a significant sum of money.
David Milberg is a financial analyst from New York City.