Rent-To-Own: How to Buy a Home When You Think You Can't Afford It

By Terin Miller

So you want to buy a home, but your credit isn't good or you think you can't afford the down payment.

If renting is affordable, and buying isn't, how can you ever hope to buy a home?

A third alternative - renting-to-own - exists. In fact, it has existed for decades.

According to the most recent National Multifamily Housing Council survey, renting is still more popular with millennials than other generations, for three reasons: convenience and flexibility; not having enough saved for a down payment; or having recently moved and exploring neighborhoods.

To qualify for a mortgage, most advisers recommend buyers have a good credit score and cash for a down payment. Generally, an acceptable down payment is considered around 20% of the purchase price of the home, whether it's a condo, apartment, or house.

But it isn't necessarily as unaffordable as you might assume.

"The average person, or say a millennial, thinks 17% (of the purchase price)" is the minimum needed; "Fannie Mae says it's 13%, when in fact it's 5% or less for FHA (Federal Housing Administration) mortgages," according to Douglas Robinson, spokesman for Neighborworks America's Washington, D.C., headquarters.

Pros and Cons of Rent-to-Own

In a rent-to-own agreement, a buyer agrees to rent the home for a set amount of time before exercising an option to purchase the property when or before the lease expires. The size of the option is negotiable, and there is no standard rate or time period, though the average seems to be about 2.5% to 7% of the purchase price. In some contracts, all or some of the option money may be applied to the purchase price at closing. So, for example, with a purchase price of $200,000, a 7% option consideration would mean the buyer would need to pay $14,000 up front-significantly less than a 20% down payment of $40,000.

Which is what makes a rent-to-own agreement an option for people who want, but aren't yet financially ready, to buy a home. Renting to own gives potential buyers a chance to get their finances in shape while having an option to buy the house they're already living in and would like to own.

Advantages to renting-to-own could be that the property is in a location in which you can't currently afford to buy; locking in the fact you're going to live there, and such an agreement "might be the tool for you and include some of your rent payment going to a purchase agreement so you lock in the price ahead of time," Robinson said.

On the downside, if the price isn't locked in, the rent isn't going anywhere except to the landlord-and you could be locked into paying a three-year lease and not get anything out of it.

As with any homeownership or even renting option, while it may appear to be attractive, Robinson cautioned that it "could be the right option for you," though "like homeownership in general, it's not for everyone."

Generally, before leaping at any purchase option, Robinson said, you should speak to a housing counselor, a real estate agent about contract terms, and "maybe even a lawyer."

Brian Alexander, a partner at Alexander/Grossman in Chicago, said rent-to-own is most popular and frequent as an option for people who have no credit, or need time to build up credit, as well as for a seller who has had trouble finding a "normal" buyer.

Alexander notes the situation isn't necessarily regional so much as based on individuals'-the sellers', and potential buyers'-economic circumstance.

For instance, it is more likely to be an option in an area where the housing market is slow, or buyers have been unsuccessful selling their homes.

"I don't know that it's regional," he said. "It's just when the market is not good, people can't get loans, or there are depressed properties."

"Mostly," Alexander said, "it's just a way of getting your foot in the door."

Rent-to-Own for Sellers

It's popular for someone trying to sell their home as well, since the seller has a potential buyer where there was "no hope of a buyer before," he said.

In addition, "It helps obviate the issue of a down payment," Alexander said. "The way you structure it, (the seller) considers a portion of the rent to be the down payment."

If the rent is, say, $1,000, then $400 of it could be considered as "earnest money," he said.

"Rent-to-own has been an option available for a number of years," Neighborworks' Robinson said. "It goes in and out of favor for a variety of reasons. Currently, the popularity of it has risen again because home prices are pretty high, and some people have poor credit and other kinds of debt burdens that make qualifying for a mortgage to purchase difficult."

But Robinson cautions potential buyers to "give pause before entering in that kind of agreement."

As an alternative to renting-to-own, Robinson suggested, you may want to wait a few months to improve your credit, or think about moving even a few blocks over where prices may be cheaper.

Five Things Potential Rent-to-Own Buyers Need to Keep in Mind:

  1. What is the final purchase price being agreed to? Is it the current fair market price, or is it a future fair market price? For instance, if you're buying a house for $250,000, is that the current price of the house today, or when you plan to purchase the home in say three years?
  2. Are rent payments going toward a down payment kind of fund that would help you make that purchase, or not? It should be clear which is which.
  3. Potential buyers should know if they can get out of any contract that they're in for rent-to-own, as circumstances change with time. "Perhaps," Robinson said, "You don't want to live in Kansas City. You want to get married and you want to move." Will you be penalized? Does that (option) money come with you or, like rent, disappear into the landlord's pocket?
  4. There are a lot of moving parts between legal agreements. What are your responsibilities as a rent-to-own tenant? In a straight rental, when there's a structural or damage problem it's the landlord's responsibility to fix it; is that the same in your rent-to-own? You really want your responsibilities laid out as far as occupancy.
  5. And, lastly, what drives change in the purchase price?

Statistics on Millennial Homeowners

According to statistics from Zillow.com, the leading real estate and rental marketplace, 39% of millennials surveyed last year are able to make the recommended down payment of 20% or more for buying a home, and 21% put down the bare minimum in order to secure a home loan.

That being said, Zillow said recently that, in the strongest quarter for household formation since 2015, the United States gained 1.1 million new households in the fourth quarter of 2017, a 0.9% increase from the previous quarter.

And young adults under age 35 drove the increase, with home-ownership rates for households headed by someone age 35 growing 1.3 percentage points to 36% over the past year-the largest year-over-year percentage point increase since the fourth-quarter of 2014.

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