Everyone has to live somewhere, so many find renting to be the best option due to low credit score, lack of funding for a down payment, and the general uncertainty of whether or not they’ll live in a home or an area long-term. Making the jump to homeownership can be difficult given the financial burden, so the idea of paying rent and having that money ultimately used towards your purchase of a home seems like a fabulous idea, but there’s more to it than that.
Every business transaction must be advantageous for both sides, otherwise, why would they enter into it? Let’s look at what each side is dealing with:
- If a seller is listing a home for sale, they have the intent to liquidate their investment. They want to sell it, not continue to hold it and rent it out. There are risks and expenses associated with renting a home and many sellers aren’t looking for those responsibilities anymore.
- If an owner is going to rent a home, they want to receive the market rate of rent. They’re not going to willingly accept less than properties that are similar based on condition and location, unless there’s a good reason.
- In this market it is easy to sell a home, there are more buyers than properties available, so sooner or later the seller can offload their investment and walk away with cash (as long as they’ve priced it appropriately, of course).
- Wants to purchase a home, but doesn’t think they have enough funds available for a downpayment. This likely means that they don’t have additional funds to afford housing that is higher-priced than the market rate of rent.
How does rent-to-own work?
For this type of deal to work, the seller retains ownership of the home while the buyer becomes a long-term tenant. During this time the tenant normally pays more than the home would rent in the market. For example, if a home would rent for $1,800 monthly, the tenant may pay 2,000 or more each month. 1,800 of that payment would go to the seller as rent, the remaining portion of the payment would be held as “savings” towards the downpayment. This downpayment savings grows very slowly, and the buyer must pay an upfront fee to place this purchase option into effect, which often takes away the advantage of this transaction setup.
There’s also significant risk to the buyer and the seller. The seller is staying as the owner, which means they foot the cost of insurance and taxes. Also, the buyer is under no obligation to purchase the property at the end of the deal. They may lose some or all of their “savings” but again, that isn’t very much money to begin with.
These deals are more advantageous in a real estate market where there’s too much inventory and it’s difficult for a seller to offload a property. In that type of market environment there’s an advantage to renting the property in the hopes of selling at a later date than to let it sit vacant for long periods of time. This is the same market environment when we see sellers financing deals instead of requiring buyers to go and get their own loan from a traditional mortgage lender or bank.
In our current real estate market where buyers far outnumber available properties and home prices are increasing, you can still find rent to own properties advertised, but many (if not all) are scammers. So buyer (or tenant) beware!