We’ve all seen those oh-so-tempting “rent-to-own” signs that try to convince would-be homeowners that dreams really can come true. And sure, at first blush, a rent-to-own deal might seem like an easier path to homeownership, especially for first-time buyers who are struggling to overcome credit issues or build up a down payment.
But like with most money matters, the road is fraught with peril. And buyers have to tread that road very, very carefully to keep from getting bamboozled. Here are a few things to keep in mind before you sign a lease that ultimately becomes a mortgage.
So, what is rent-to-own anyway?
A rent-to-own home deal is pretty much what it sounds like: a hybrid of renting and homeownership.
Initially, when you sign the deal, you’re a renter. You’ll move in immediately and pay the seller rent each month, often at a higher rate than for other traditional rentals. But a portion of that rent is typically put toward the purchase price of the home, and at the end of the lease contract term, you have the option to buy the home outright.
Expect to shell out cash upfront
Once you get past the basics and into the nitty-gritty, things get more complicated. While a normal rental lease has just a few upfront fees—such as a security deposit, first and last month’s rent, and pet fees—rent-to-own homes require significant amounts of money upfront.
This fee often isn’t refundable. Instead, it may be considered simply a fee for setting up the deal. After all that, buyers will also need to build up a down payment and, when the time comes, pay closing costs. Some sellers may also require security and pet deposits upfront.
When all is said and done, the total cash amount you’re out could be hefty—and buyers should be leery.
The devil is in the details of the contract
Unlike a standard lease with the usual rules and one-year term, rent-to-own homes will come with lengthy contracts, and you’ll want to pay attention to all the details.
First, the length of the rental period is set by the seller and can vary widely—typically anywhere from six months to three years, according to Brandt. While a longer contract buys time for the buyer to build up credit and a down payment, it also leaves more time for something to go wrong.
Since the seller is writing the contract, it could wind up heavily in his or her favor. These contracts can “contain subtle clauses that might hurt the buyer down the road,” Brandt says. There are state laws that protect buyers in many cases, but sellers can dream up any number of legal loopholes, and buyers have to tread carefully to avoid problems in the months to come.
The seller is also your landlord
Typical rent-to-own deals have one potentially terrifying aspect in common: The seller is your landlord. That means that while you may be planning to buy the home in the future, you still have to follow all the typical landlord and tenant laws. If you don’t, you’ll risk an eviction, and that is a very bad thing.
“If the renter fails to pay rent, they may be evicted, losing their option fee and money they’ve put toward the purchase price,” Brandt says.
Check—and double-check—your agreement
Even if the rental side goes smoothly, buyers might set themselves up for a shock when it comes time to actually buy the home.
For example, mortgage underwriting guidelines are very specific and an underwriter may not agree with the terms on your original rent-to-own terms.
To avoid the potential pitfalls, hire a real estate attorney to go over the contract with a fine-toothed comb before you sign on the dotted line.