Too Good to Be True: The Pitfalls of Rent to Own Homes

Renting a home is cheaper than buying one — this is a mentality that persists among many American adults. It is true: the average rental price in all 50 states in America is at around $500-1,500, while the average monthly housing payment plus mortgage ranges at $1,500-2,500. Homeownership offers financial security, however, making it more attractive than renting for the rest of your life.

Having your name on your home’s deed and title offers security and peace of mind. These drive people to work hard and save for a downpayment on their dream home. Unfortunately, despite their efforts, there are some who still don’t qualify for a mortgage or housing loan.

If you are in the same shoes, I daresay you must have considered rent to own housing programs. In theory, they are the perfect way to becoming a homeowner: A rent to own enables you to live in the house you love and eventually buy it after a few years.

That’s not all there is to it, however. Rent to own programs can quickly turn into “too good to be true” scenarios that would later prove all suspicions right. Here’s how it happens.

How it Works

Rent to own buys time for aspiring homeowners who have a low credit score and therefore cannot get a loan. They get to live in the house they want to own even as they work on improving their credit score. Ideally, they’ll have saved enough and obtained a loan in three to five years — the typical payment period for rent to own houses — and finally be able to purchase the house.

Essentially, rent to own offers you first dibs on the property. You won’t need to worry about other buyers sweeping in while you’re saving up for a downpayment or working on getting a home loan. It’s a good arrangement, one that’s favorable to the buyer. Unfortunately, these programs are not without its pitfalls.

High and Increasing Rates

Interest rateWhen renting to own, you need to pay a premium for the privilege of first option. The rent premium typically goes to escrow, which you can later use to buy the house. The rent premium could be a percentage of your monthly rent or a fixed fee. You may have to pay $1,100 for the rent, for example, plus an additional $250 for rent premium each month. Be warned: Rent premiums are often non-negotiable. If you change your mind later on and decide not to buy the house, you won’t get a refund on your purchase investment.

There’s also a possibility of paying higher rates for each successive year. Expect the latter if you sign a rent to own with lease terms that require you to pay market-rate rent. Note that from 2012 to 2017, the annual market-rate rent increases averaged 5 percent. Given this average, the Freddie Mac website says people renting market-rate units pay $7,500 more than those with rent-restricted units.

Wordplay in Contracts

I’ve heard of many unpleasant stories about rent to own programs, and I’ve realized one thing: The devil lies in the details of the contracts. Agents will sell you the best parts about the program but neglect to point out the crucial portions of the fine print.

Watch out for these terms and clauses in rent to own contracts as they could trap you in a financial dilemma.

  1. Lease Option vs. Lease Purchase

A lease option gives you the first option to buy a home for the duration of the program period. You’re free not to go through with the purchase if you change your mind later on. A lease purchase, on the other hand, binds you to the property. Regardless if you lose interest in the house or its property value decreases, you’re bound to buy the house at the end of the program period at the price you first agreed on.

Be careful about the terms used in your contract. To be safe, decline a contract with a lease purchase clause.

  1. Rent Premium (or the Lack Thereof)

Some rent to own programs may waive the rent premium discussed earlier; this is not necessarily good news. The owner could still charge a high rental rate, only this time you don’t have an escrow account that will go towards buying the house.

  1. Purchase Price

It is customary for owners to increase the purchase price of the house for each successive year. It is to encourage tenants to buy the property as soon as possible.

Rent To Own Contract

A purchase price scheme can look like this:

Buy the house within Year 1: $230,000

Year 2: $240,000

Year 3: $255,000

Year 4: $267,000

Year 5: $275,000

A $50,000 increase in the purchase price is unsurprising in rent to own programs. If you fail to factor in the fixed inflation, you may have a hard time buying the house at the end of your lease.

  1. Ongoing Expenses

Some rent to own contracts pass the maintenance and upkeep expenses over to the tenant. This practice is meant to encourage tenants to care for the house and start treating it as their own. Unfortunately, this can also spell additional expenses if the house has latent defects.

It’s alright if you’re willing to gamble on a property and shoulder ongoing expenses. Just make sure you’re not at the losing end of the deal. My advice is to review clauses that absolve the property owner of all maintenance costs if the property has seen better days.

Go All In or Walk Out

Couple thinking about buying a home

It is clear that renting to own is no less binding than homeownership. It may offer you a more affordable rate at the moment, but expect your housing expense to climb for each successive year. Also, when you enter a rent to own program, you can’t afford financial missteps. Remember, you’re paying more than the average renter. At the same time, you’re building up your credit score so you may soon qualify for a home mortgage.

Rent to own properties demand that you go all in. If you can’t keep up with the increasing rent, save for a downpayment, improve your credit score, or secure a mortgage before your lease expires, you’ll have no choice but to bow out. It’s a gamble, and it’s one you should make with both eyes open.

For more advice on real estate and financial management, read our other blogs.

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