What is a Rent-To-Own Contract?

We find that many folks tossing around the phrase "rent-to-own" do not have a clear picture of how that process works.

"Rent-to-own" is a situation that generally heavily favors the seller/landlord over the buyer/renter & is only very rarely a good idea for home buyers. Rent-to-Own contracts are very rare in a strong, healthy, housing market like ours. No foreclosures, short sales or other distressed property owners will consider rent-to-own deals.

Only a very small percentage of homes that are for sale (in this market) will be able to even consider a rent-to-own offer. The majority of people selling need the proceeds from the sale of their home to buy their next home (or avoid foreclosure.) Therefore, the selection of properties to consider will be very limited; probably less than 5% of homes for sale currently could even consider a rent-to-own offer. 

In a rent-to-own (or lease-to-purchase, or rent-to-buy) deal the buyer signs a contract that must be prepared by an attorney. In NC, that contract must address these possibilities: sellers' default, buyers' default, and what happens in case of foreclosure. Since it is drawn up by an attorney, the seller and buyer can agree to just about any terms they can dream up so there is no one absolute definition of how it must work. But, here, we will describe how it typically works. 

Typcially: The lease-to-purchase contract is an agreement to buy a specific property at some specific date in the future for a price that all agree on now. For the time period between the start of the contract & the purchase date, the buyer will rent the property for an agreed upon market rate of rental. In addition to the normal monthly rent, the buyer also normally pays an up-front earnest money deposit toward the purchase plus an additional monthly amount towards the purchase price of the home (above the normal rent.) All of the amounts are negotiable. 

An Example Scenario:

Let's use some reasonable numbers as an example:

Let's say you find a house, townhome, or condo listed for sale for $250,000 and for rent at $1600/month that you want to rent-to-own. You want to move in/start renting on July 1, 2017 and agree to buy it on July 1, 2018.  

First - you would negotiate for the purchase price of the home for the sale date of 7/1/2018. Let's say you & the sellers agree on a price of $240,000 with an earnest money deposit of $5000. (The seller will not be as willing to negotiate the price for a sale that is a year off as they will for a normal closing to happen in 30-45 days.) The seller/landlord will check the renter/buyer's credit and must be convinced that the buyer will be able to qualify for a mortgage by the closing date (or have the full amount in cash.)  You agree to rent the place for $1600 per month. In addition, the contract requires that you pay an extra $200/month towards the purchase of the home.  

In this scenario, you would write a check by 7/1/2017 for $5000 that goes into a trust account. You would also pay your first month's rent of $1600 to the owner plus probably another $1600 as security deposit that also goes into a trust account. Each month after for the next year you would pay $1800 or which $1600 is rental income to the owner and $200 goes into the trust account to be applied to the purchase price on 7/1/18.  If you buy the house as agreed in the contract on 7/1/18 for $240,000, your earnest money deposit of $5000 plus the 12 payments of $200 ($2400) are all applied to the $240,000 purchase price of the home -- leaving a balance due of $232,600 at closing (plus loan fees, closing costs, and such.) Your rental security deposit of $1600 is refunded to you.  The $1600/month in rent is not applied to the purchase price. Many buyers mistakenly assume that their full monthly rent payment is being applied to the purchase price. That's not normally the case.

If, for any reason, you are unable to buy the house on 7/1/18 as per the contract (if you just change your mind, find a home you like better, or cannot qualify for the mortgage), the seller is typically entitled to keep the $5000 deposit plus the $2400 for breach of contract. Only your $1600 security would be refunded (if the house is in suitable condition.)

During the rental months, the seller still owns the house and has final say on any improvements or changes you'd like to make to the house.  All the risk is on the buyer. The buyer may also worry that the seller could be foreclosed on in the year they are renting.   

Summary:

The only time we see a rent-to-buy scenario make sense for a buyer is if they are getting such a good deal on a very unique home that they feel they absolutely "must" have and they are 100% certain that they can and will buy the home within a year. The typical rent-to-own buyer is waiting for a big chunk of cash they know for sure is coming  -- such as from the sale of a home or business under contract, a divorce settlement, other legal settlement, or company bonus. 

Most of the time it is better for buyers that aren't ready to buy just yet to simply find a straight rental first. Then save money, improve credit, or do whatever they need to do until they can get into a position where they are ready & able to buy. Then they can look for the best deal on the perfect place to buy and negotiate from a much stronger position. If it turns out that you still want to buy the place you are renting, that's great. But why limit your options a year in advance?

In North Carolina typically lease than 8% of lease-purchase contracts ended in the purchase of the property. That means a lot of people lose a lot of money in deposits.

Ask us any questions you may have.