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When Stephen Keighery moved from Australia to New Orleans, he faced a homebuyer’s Catch-22: he didn’t have bad credit, he had no credit.
His solution: a rent-to-own agreement that allowed him to build his credit and save for a down payment before purchasing.
“It’s really ideal for people that don’t have credit established,” the real estate agent and investor said. “I had no history here, which I’ve started to build up now.”
What Is Rent-to-Own?
Rent-to-own is a homebuying strategy that involves leasing a home with the option to buy at the conclusion of your rental period. Sometimes a portion of rent goes toward equity in the home, though the percentage and terms vary. Before pursuing any rent-to-own agreement, you should agree on a final sale price first even if you don’t end up exercising your right to buy.
“When you typically think about rent-to-own, you think of someone as a tenant in the home and part of their rent is getting used for the benefit of a down payment or for the benefit of a purchase,” says Charles Gallagher, a real estate attorney in St. Petersburg, Florida.
Benefits of Rent-to-Own
Rent-to-own can help people in certain circumstances buy a home sooner than they’d otherwise be able to. For individuals who don’t have the credit or down payment for a mortgage, but are otherwise on sound financial footing, a rent-to-own agreement can help them get into a home and set them up for purchase later.
You can negotiate your rent-to-own agreement. It may be possible to increase the percentage of your rent payment going to equity or your down payment.
With a rent-to-own agreement, some part of your monthly lease payment accrues with the landlord as a down payment, says Gallagher, helping to ensure there’s a down payment saved up at the end of the lease period.
What to Watch Out For
Rent-to-own agreements can work well for people in certain circumstances, but Gallagher said he’s defended clients who didn’t know exactly what they were signing up for before going down this path. Buyers should pay close attention to their rental agreement and terms, and watch out for these other red flags:
1. Be Skeptical If You Get Approached
“The first rule of thumb would be if someone’s approaching you, if someone seeks you out, that’s always a red flag,” says Gallagher. Especially if you’re in a tough situation with rent, and someone offers a deal to buy that seems too good to be true, it probably is, says Gallagher.
2. Research Comparable Rent
You should not be paying rent under a rent-to-own agreement that’s considerably higher than what you’d pay for a similar property in the area. It’s also a good idea to get an independent appraisal of the property to be sure the seller hasn’t inflated the value of the home.
3. Do Your Due Diligence
“It seems as though people kind of skip over that, because they still think it’s a lease,” says Gallagher. But if you have the option to buy your property at the end of the lease, and you’ve agreed on a purchase price, you should do all of the things you would do when looking into buying a house the traditional way.
That means getting a home inspection and appraisal to “make sure that what you’re getting is a good house. You’re making a significant investment, you don’t want to get a house that’s got problems,” Gallagher says.
How to Find a Rent-to-Own Agreement
Most rent-to-own agreements come up situationally, as in Keighery’s case, wherein he and his family agreed with an owner to buy a house they’d initially rented. But talk to your real estate agent to find options that may work for you.
When negotiating a rent-to-own agreement, Gallagher recommends the following steps:
- Agree on a purchase price
- Use the purchase price to figure out what your down payment will be, and negotiate part of your rent each month to go toward that number
- Your lease term should not be longer than two or three years
Your lease agreement should include the exact amount of your lease payments, the terms of your option to purchase, and who is responsible for things like utility payments and repairs during the lease term. The department of housing and urban development provides an example rent-to-own lease agreement that you can use as a guide.
Rent-to-own interest among prospective buyers has also driven new business innovation in the space. Startup company Divvy Homes has raised millions and expanded its rent-to-own services to nearly a dozen cities in the U.S. in recent years. It offers a path to home ownership that follows the track of other rent-to-own agreements.
“The goal was to help provide access to homeownership for a greater percentage of Americans,” says Adena Hefets, CEO and cofounder of Divvy Homes. The company helps consumers in 10 cities get into rent-to-own homes.
A rent-to-own agreement could get you into a house you love more quickly, but make sure you know exactly what you’re signing up for.
“If you can access a mortgage, we think you should,” Hefets says. “If you don’t have a down payment saved up, or if you have a credit hiccup, anything that might make getting a mortgage more difficult, it can be a good option.”
Make sure you understand all the terms of your rent-to-own agreement.