Rent To Buy

Introduction

Rent to Buy can be considered as a funding source and a real estate niche. First home buyers with no chance of landing a traditional bank loan will find it attractive as a potential funding source. No matter how you look at Rent to Buy, the basic concept is quite easy to understand.

For those thinking of going down the traditional route to home ownership by way of securing a bank loan to finance the purchase, you’ll need a good credit score, a sizeable deposit, plus proven ability to repay the loan. This will be a challenge for many people for a variety of reasons.

However, there are numerous alternatives to bank loans which give buyers who are not financially stable a chance of owning a house. Rent to Buy is one of these. Also known as Rent to Own, Option to Buy, Lease Option and Lease Purchase. Note – there can be important differences between each of them, so it is best practice for a real estate attorney to look over the terms of any agreement you may enter into.

What is Rent to Buy?

It's a kind of contract where you agree to lease a house for a specific time until a mortgage is secured to pay out the purchase amount, enabling you to gain ownership. The time involved varies but is usually for between one year and five years. The buyer enters into a standard rental agreement with an option to buy which gives them the right to buy after the agreed period.

How Does Rent to Buy Work?

The contract between the buyer and the seller will involve a standard rental agreement and the option to buy.  A non-refundable deposit or option fee (typically five or ten percent) is required by the seller and this will count towards the purchase price of the house when the buyer secures a mortgage. During the rental period, the buyer should be building up a good record of paying on time which will help to secure a mortgage. Once a mortgage is obtained and the owner paid in full, the property’s title and deed will be transferred to the buyer.

Throughout the rental period, the buyer pays rent which in most cases will be above the market average. A portion of the rent, around 25%, should be applied to the end purchase price. This percentage needs to be negotiated by the buyer and seller prior to signing anything.

Main Negotiation Points

Remember, nothing should be signed until all points are agreed to by both parties.

  1. Purchase Price

You can use the home's current value or it’s predicted value when the buyer should have obtained a mortgage to complete the purchase. The predicted value might be current value plus five%.

2. Non-Refundable Fees

The buyer pays a fee to the current owner and this is non-refundable. This I called an option fee and gives you the option to buy the property at a specific date in the future. The fee is negotiated between the parties and is usually 1% to 5% of the purchase price but can be higher.

3. Lease Option vs. Lease Purchase

Be aware of the two types of a rent-to-buy agreements.

  1. Lease Option: This gives you the right to buy the property, but you are not under any obligation to buy. You may decide not to buy when the lease ends. The option will expire and you can move on and not pay any further rent. 
  2. Lease-Purchase: With this agreement, you are legally obligated to purchase the house even if you are unable, or unwilling, to buy the property. The seller can sue you for this.

It's always a good idea to review the contract with a real estate attorney to make sure there will be no surprises in the contract.

4. Rent Portion Applied to the Principal

You will likely be paying a premium on your rent for the duration of the lease term. But what portion of that rent is being credited towards the purchase?  A percentage should be worked out and included in the agreement eg 10, 15, 20%. This will greatly reduce the loan amount you’ll require at settlement.

5. Repair/Maintenance Responsibilities

The seller continues to be the owner of the property until the buyer tenant secures a mortgage and pays the full purchase price. An owner (the landlord) is responsible for maintenance and repairs but don’t simply assume that is the case. Taxes and insurance are not your responsibility. Be clear about who replaces/repairs dishwashers, hot water systems, broken electrical goods, leaking water pipes and clogged up gutters. Property taxes have to be up to date prior to signing the contract. Before moving in, the buyer should thoroughly inspect the house and report issues that should be repaired by the owner.  

Paperwork Involved in Rent to Buy Agreement

A rent to buy agreement is a combination of a standard lease agreement and a real estate purchase agreement/contract of sale. These agreements can be known by other names in some states. Have your real estate attorney involved in the drawing up of the contract.

Conclusion

Rent to Buy allows a buyer to move into the house right away. The buyer in time can improve their credit score and save for a down payment before trying to secure a mortgage. Equity can be built up if the option fee and a percentage of the rent is credited towards the purchase price.