What is a “rent to own” home?
Basically, it is exactly what it sounds like it is. It’s a home, owned by a homeowner or investor, that is rented out to tenants. However, the tenants have the “option” to purchase the home within a certain period of time for a predetermined price.
Some homeowners use this strategy in order to sell their home, even though it means they have to accept payments for the period of the rental term. A home buyer who may have less than perfect credit or lack the money needed for a down payment may find this to be the ideal way to buy a home. It will enable the buyer to move into the home while they build their credit and save their down payment through personal savings and rent credits.
For an investor, this method is similar to a covered call. The tenant pays the investor a “premium”, up front for the option to purchase the home in the future. This premium is called the “option deposit”. The expiration of the option, which is negotiated beforehand allows the buyer to purchase the home at a predetermined price. The seller sells the home based on the terms of the rent to own agreement. The option deposit, along with any rent credit, becomes part of the buyer’s down payment.
How Does “Rent to Own” Work?
The homeowner or investor lists their rent to own property. The rental amount will be on the high end of the local rental market, and a small options deposit of 1 to 2 percent will be required in order for the “tenant” to move in. The option deposit is non-refundable, but it will go towards the purchase of the home if the tenant decides to purchase the home at the end of the rental term.
The tent moves into the home after they give the landlord the deposit and rent. They will each need to sign a lease agreement and a purchase agreement. Each month a small portion of the rent will be put towards the purchase of the home. This money is called the rent credit. The amount of rent credit is at the seller’s discretion. If the seller does not buy the property, they do not receive their deposit or rent credit after they move out.
From an Investor’s Perspective
- The option deposit is collected upfront.
- The rent on these homes is typically higher.
- The tenant is responsible for all repairs and maintenance.
- The tenant will treat the home as though it was their own, so it will be better cared for than a typical rental.
- The sale is guaranteed it the tenant exercises their option.
- A ceiling is set on the selling price, which may mean they’ll lose money in an appreciating market.
- There is a certain amount of due diligence needed to screen potential tenants.
- The investor is bound by the terms of the agreement, but the tenant can walk away at any time.
From the Tenant’s Perspective
- The tenant can “test” the home and neighbourhood to see if it’s a good fit.
- The tenant can walk away at any time.
- The tenant can build their credit over the length of the rental term.
- The tenant can build their down payment with savings and rent credits.
- The tenant must pay a premium rent and an options deposit.
- The tenant will lose the options deposit and the rent credit if they don’t buy.
- The tenant is not guaranteed that they will qualify for a bank loan at the end of the term.
For an investor, this is a good way to make money in real estate. However, it may be a deal breaker because it places a cap on the selling price. It may be better to build equity in the home over time and keep the property as a long-term investment. However, this is a viable solution for a homeowner who wants to sell their home in a competitive buyer’s market.