Stupid Money: What Exactly is a Rent-to-Own Home?

Beware of the fine print…

rent_to_own

The media loves few things more than talking about millennials. When writers tire of getting their panties in a tangle about avocado toast or smartphone use or participation trophies, we get treated to stories about how millennials love to rent their homes.

That’s right, we love to rent our homes instead of owning them! LOVE. IT.

To set the record straight here, it’s not because we blow all our money on sustainably raised, conflict-free, mindfully prepared avocado toast. Wage stagnation and crushing student debt can kinda get in the way of people’s dreams, you know? But it turns out there’s another way: Renting to own. Such arrangements have been around for a while, but what they hell are they? Why are Silicon Valley types starting to push them? Do they work? And are they some kind of scam? Let’s find out!

I thought rent-to-own was for, like, sofas and electronics and stuff.
True. But landlords have been doing them for a long time also. They’re not particularly widespread — it’s more of a case-by-case basis. Also, sometimes they’re more common in a recession, as investors buy up foreclosed properties and make money on them this way. Or maybe the seller simply can’t find any buyers and is open to a rent-to-own arrangement (draw your own conclusions about the state of the property, or its location, if a house isn’t getting any offers — at least right now). Maybe they’re interested in selling eventually, but have no urgency to do so. Property owners can be eccentric people! Who knows what motivates them?

Keep in mind that there’s no industry-standard rent-to-own arrangement: They can vary widely, and it must be said, they should be scrutinized closely by a real estate attorney if you go this route. Caveat emptor, and all that (more on the practical ins and outs of rent-to-own in a bit.)

So are they a scam, or what?
Well, anything involving money, and especially a bit of math, can potentially be a scam, right? They’re not scams per se. It’s just that both parties have to negotiate the terms carefully and know what they’re getting into, as this can be very different from a standard purchase.

How does it go? What are the kinds of terms at stake?
There are so many! Basically, everything is negotiable. Here are the most common ones, for both buyers and sellers:

  • Know what the ultimate purchase price will be: Is it a fixed amount, say, current value plus 15 percent? Or whatever its appraised value will be at the end of the lease term? Or will it fluctuate based on… something?
  • Know if — or how much of — the rent money is going toward the purchase or not: In a typical agreement it will probably be, like, 20 percent or whatever — just read the fine print! If some rent money is going toward the purchase price, the rent should be a bit higher than market rate, since the tenant is buying equity with it. One variation is a right of first refusal, where the owner puts it up for sale as it’s being rented, and the tenant gets to match any offer on the property (in which case, the rent money might not be going toward the purchase).
  • Know if the tenant has to purchase the property at the end of the term: There are lease options and lease purchases. The lease option gives the tenant the choice to walk away, whereas a lease purchase requires them to buy it — whether they can afford to or not!
  • Know who will handle any repairs: As it’s being rented, is the tenant or the landlord gonna pay for the broken water heater? Who’s gonna mow the lawn? If it needs a new roof, who reaches for that bill?
  • Know, as a renter, if you’ll get anything if you walk away early: If for some reason you opt out of purchasing or have to leave, be clear about whether you get anything back from it.
  • Know, as a renter, if you need to put money down for this: Usually you will. That’ll be an upfront cost.
  • Know what the lease terms are, annual rent increases, etc., just like any lease! But the stakes can be higher: Maybe a single late payment, or a rule broken (like if the renter sneaks in a pet) will disqualify a renter from the purchase, for example.
  • Know if the landlord can sell it sooner if they get an offer: For renters who don’t like surprises — especially big ones — be crystal clear on this one!

As you can see, this is all pretty complicated, and best examined by the eyes of a real estate attorney. With so many variables, a seller (or a particularly savvy renter) could really create some favorable terms for themselves. Attorneys obviously aren’t cheap, but neither is a terrible financial arrangement.

What kind of renters/buyers tend to go this route?
People who maybe don’t yet qualify for a conventional loan (because they’re building back their credit, or whatever), or people who want to live in a certain house or a certain neighborhood but can’t yet afford to put down 20 percent of the purchase price (the typical down payment arrangement). Even people who are self-employed or contract workers (i.e., almost everybody) can find it hard to get a conventional loan these days. The obvious advantage for a tenant to go this route is that they get to live in the home they want to buy even if they can’t yet afford it, but are able to pay slightly-above-average rent.

How long are the lease terms?
Usually one to four years. It’s not like a 30-year mortgage or anything like that.

What should I be sure to do, then, before I go this route?
Renters should get pre-approved for a mortgage, if they can, based on what the purchase price will be. And sellers should ideally have their renter do this too — you don’t want to reach the sale and then not have the money lined up. Also, get an appraisal done, as you wanna be clear on what the home is worth.

Tenants should be sure do their homework on the seller — their credit history, how long they’ve owned the property and all that — in the hunt for red flags, just as landlords do for tenants. If the landlord is a big investment company, it might offer credit counseling/repair to the renter, which is nice (also, the big companies generally operate above board, legally, since they’re publicly traded and thus subject to regulatory scrutiny).

Finally — have we mentioned this yet? — lawyer up! A real estate attorney will know all about these arrangements and can sniff out anything fishy, and help get you a fair deal whether you’re the buyer or the seller.