Homeownership is a dream many Americans still aspire to achieve, with 81 percent sharing that goal according to a recent survey. However, if you face challenges like having no credit or bad credit, or if you don't have money to put down, buying a home might seem more like a dream than a possibility.
If the traditional route to buying a house doesn’t currently seem feasible, maybe you’re considering some alternatives. Perhaps you've heard of renting to own a home and are considering it. But what does it really mean to rent-to-own?
How Does Rent-to-Own Work?
It works something like this: You sign a lease, agreeing to lease the home for one to three years. You'll put down a certain amount -- say three to five percent of the purchase price of the home -- and agree to pay the rent plus an additional monthly amount that is set aside, typically in an escrow account. That portion will eventually be the down payment to be used during the actual purchasing of the home.
For example, if the home would typically rent for $1,500 a month, you may agree to pay $1,800 a month, with the extra $300 going toward the down payment when you purchase the home at the end of the lease term.
If you can't afford that extra amount, this could quickly get dicey -- if, for example, you are late on your rent one month, you may forfeit the extra money for the month. And, if the property owner doesn't feel that you are living up to your end of the deal (paying rent late, not abiding by the lease terms, etc.), they can evict you -- and you won't get any of that money back.
On the other hand, if you pay your rent on time, you will be building your credit while saving a nice down payment, making it easier to qualify for a home loan.
What to Know About Renting to Own a Home
If you decide it's worth the risk, there are some steps you should take to protect yourself. First, make sure you will qualify for the loan at the end of the end of the lease term. Consult with a mortgage lender to know exactly how much you'll need for the down payment and how much you'll qualify for. If you don't do this, you may end up not qualifying for the loan at the end of the lease term -- and all that extra money you paid won't be refunded.
If you have a low credit score, the rent-to-own lease period is a great time to improve your credit score, improving your changes of securing a mortgage when the time comes. Here are some ways to improve your credit score:
- Timely Bill Payments: Consistently paying your bills on time is one of the most significant factors in boosting your credit score. Set up automatic payments or reminders to ensure you never miss a due date. This includes not just your rent, but also utilities, credit card bills, and any other recurring payments.
- Reduce Outstanding Debt: Work on lowering your overall debt, especially credit card balances. Aim to keep your credit utilization ratio below 30%, which means using less than 30% of your available credit limit. Paying more than the minimum on your credit cards each month can help reduce your debt faster.
- Monitor Credit Reports: Regularly check your credit reports for errors or discrepancies, as these can negatively impact your score. You're entitled to one free credit report per year from each of the major credit bureaus (Equifax, Experian, and TransUnion) through AnnualCreditReport.com. Dispute any inaccuracies you find to keep your credit profile accurate.
- Open New Credit Accounts Wisely: While it might be tempting to open new credit accounts to increase your available credit, doing so can temporarily lower your score due to the hard inquiry. If necessary, open new accounts sparingly and focus on managing existing credit responsibly.
- Keep Old Credit Accounts Open: The length of your credit history affects your score, so try to keep older credit accounts open, even if you don't use them frequently. This can help build a longer, more robust credit history.
- Consider a Secured Credit Card: If your credit score is low, consider using a secured credit card to help rebuild your credit. These cards require a security deposit, which acts as your credit limit. By using this card responsibly and paying it off each month, you can gradually improve your credit score.
Lease-Purchase Agreement vs. Lease with Option to Buy
Make sure you are entering a lease with option to buy agreement -- not a lease-purchase agreement. This is important, because if you sign a lease-purchase, you are obligated to purchase the home at the end of the rental period. If you don't, the property owner can sue you. If it is a lease with the option to buy, you aren't committed -- you can walk away if you change your mind.
But if you decide to walk away, it will cost you -- that initial payment of three to five percent may be forfeited, along with the extra monthly payments. Also, be aware that the price of the home is locked in -- this could be a great thing for you if the property value goes up while you are renting, but it could also go the other way and you'll end up paying more than the home is actually worth.
Pay Attention to Market Trends
Before entering into a rent-to-own agreement, make sure you’re aware of the current market trends in your area. Several factors, including interest rates and housing market fluctuations, can significantly influence both the attractiveness and the risks associated with these types of agreements. As you review market trends, keep the following in mind:
Rising Interest Rates
As interest rates increase, the cost of borrowing becomes more expensive, which can deter potential homebuyers from traditional mortgages. This scenario might make rent-to-own agreements more appealing, as they allow prospective buyers to lock in a purchase price while waiting for potentially more favorable borrowing conditions. However, it's essential to carefully evaluate the agreed purchase price in the contract, as future market conditions could shift.
Housing Market Fluctuations
The housing market is subject to cycles of ups and downs, influenced by economic conditions, supply and demand, and other factors. In a booming market, rent-to-own agreements can be advantageous if the contract locks in a price lower than future market values.
Conversely, if the market experiences a downturn, buyers might find themselves committed to purchasing a home at a price higher than its current market value. This risk underscores the importance of thorough market analysis and financial planning before entering a rent-to-own agreement.
Supply and Demand Dynamics
The availability of homes and buyer demand can also impact rent-to-own agreements. In tight markets with limited inventory, rent-to-own can offer a competitive edge by securing a home without immediate full purchase. However, in markets with ample supply, traditional buying might offer better opportunities, making rent-to-own less advantageous.
Rent-to-Own Alternatives
For those who find the rent-to-own process too risky, there are several alternative home-buying options worth exploring. These alternatives can provide more secure pathways to homeownership, often with additional financial support or creative financing options.
Government Programs for First-Time Homebuyers
Various government-backed programs can assist first-time homebuyers in securing a home with little to no down payment. Programs such as FHA loans, VA loans for veterans, and USDA loans for rural properties offer more accessible lending terms. These programs often come with lower interest rates and reduced down payment requirements, making them attractive options for eligible buyers.
State and Local Assistance Programs
Many states and municipalities offer grants, tax credits, and down payment assistance programs specifically designed for first-time buyers. These programs can provide significant financial support and incentives to make homeownership more attainable.
Avoiding Rent-to-Own Pitfalls
Rent-to-own homes come with an element of risk -- and the potential for fraud. Make sure you consult with a real estate agent and an attorney to protect your interests. It is also a good idea to treat this as if you are buying the home today -- get a home inspection and have any issues addressed up front.
Make sure the home isn't in foreclosure, and check for liens on the property. Be aware of the potential scams. For example, a property owner may withhold the information that the home is in foreclosure. You hand over the initial down payment and the monthly agreed-upon sum, only to lose your money and the home when the bank forecloses.
Look for hidden costs: Does the property owner expect you to pay for maintenance/upkeep of the property? It's possible, since this is a rent-with-option contract, that you may be responsible for that roof leak. Make sure these types of things are listed in the contract.
Also, be sure to ask if there are any HOA fees. If so, will you have to pay them, or will the property owner pay them until the actual home purchase?
Finally, be absolutely sure this is the house you want to buy -- you are investing money in this home, and if you walk away, you could lose all of it. If you aren't sure this is the right option for you, it may be better to rent an affordable home and save the money on your own.
