While some consumers choose to buy a home, others with financial constraints decide to rent a home with the option to purchase it in the future.
Rent-to-own homes give allows people to buy the home they are leasing and use the rent they have paid as a credit toward their mortgage down payment.
Although this appears to be a good strategy for potential homeowners who have a low credit score or do not have enough money for a down payment, there are some potential disadvantages.
Homeowners need to check the laws in their state, because it varies. One problem that could arise is what happens in the event the individual misses a payment.
Before a contract is signed, consumers should discuss the issue with a lawyer, said David Reiss, a law professor at Brooklyn Law School. In a worse-case scenario, if the individual was unable to make payments because of the loss of a job, he could lose all the payments he made previously.
"There are a lot of shady operators out there since rent-to-own transactions can be very complicated," he said.
Since there are not many consumer protections available, potential homeowners should be aware of all the options.
While this method is alluring to many people, especially younger buyers or those who have never owned a home, the possibility of "losing all the money" you have allocated toward buying the house can be a deterrent, said Larry Link, president of Level Group, a New York City brokerage firm.
Many of these arrangements are complicated, so consumers should read the fine-print and make sure all questions are answered before the ink is dry.
Here are some of the issues that a buyer needs to be aware of before embarking on the rent-to-own strategy.
If you miss a payment or two due to a hardship, job loss or illness, your entire investment could vanish. With a traditional mortgage, the amount of equity the owner has earned remains the same.
Another potential problem arises if the housing prices start to dip. Since the potential homeowner has locked in the price of the house, they are also stuck with it if values in the neighborhood start to fall.
Rent-to-own housing can be tricky because the landlord might decide the potential homeowner is responsible for repairs and property taxes during the lease period, said Rich Verrillo, a senior housing partnerships manager for Navicore Solutions, a Manalapan, N.J.-based member agency of the National Foundation for Credit Counseling. Working out all the details before the contract is signed is vital.
Homeowners still need to boost their current credit score to make sure they are approved for a mortgage when they are ready to purchase the home. Failing to qualify for a mortgage could mean losing the upfront option-to-buy fee or premium, he said.
Some individuals prefer the rent-to-own option because the burden is decreased for the tenant. The risk for the two parties will be divided when the contracts are balanced.
It gives people the ability to test out a home and the neighborhood before sinking in all their savings.
As the number of available homes in the market or a particular neighborhood can shrink and mortgage interest rates are rising, it is a good test run for many individuals, said Monica Webster, a managing director for William Raveis, a Shelton, Conn.-based real estate firm.
"It's a no-brainer," she said. "You can get your financials in order. If it's a great location and area you want, you can't go wrong. One tip is to see if some or all of the rent can be applied to the down payment."