Rent to own: three words in the English language that would
seem harmless enough if so many people didn’t conjure up the term
"predatory lending." Understandably, you hear "rent to own" and imagine
yourself financially tapped out and in a dimly lit store with dingy
carpet, signing an agreement to shell out $8 a week, until you’ve
finally paid $2,300 to buy a sofa that retails for $700.
But renting to own houses, or lease-optioning a house, as they say in the real estate business, is an entirely different business matter. For both the seller and buyer, renting to own a house can be a dream come true -- or, yes, a nightmare. It all depends on a little luck and a lot of forethought.
You don’t rent-to-sell your house to become rich. You do it to avoid becoming poor. If you’re relocating for work, scaling up to a better house or moving to adapt to some other life change and the market is preventing you from selling your home, then it’s something to consider. Unless you enjoy the prospect of paying two mortgages every month indefinitely, this is one way of minimizing the financial damage.
Let’s say that you find someone who is interested in buying the house but can’t because their credit isn’t quite right. This is how a lease option should work:
- After securing the go-ahead from a mortgage broker and before moving in, your potential buyer will give you a healthy, nonrefundable deposit to go toward the down payment of the house -- typically, 3 to 5 percent of the purchase price.
- The buyer rents your house for a period of time -- usually two years -- and during that period, they pay you monthly rent. A portion of the rent also goes toward the eventual down payment of your house.
- After two years, according to your contract, your renter has the option to buy the home, with all of the down payment money going toward the purchase price, and since they’ve put a considerable amount toward buying it, they generally choose that option. If they don’t, the seller keeps the down payment money.
Your imagination is the limit, but the most logical scenario is that your renter, after paying rent and money to go toward a down payment for those two years, still can't get approval from a bank to buy your house.
Or, arguably worse, your renter could have trouble making payments to you while you still have to pay the mortgage on your house, and you decide you want to end this relationship. Except that your renter resists being kicked out of your home, and you each get lawyers and everything deteriorates from there.
Or your renter might be a slob and treat your home poorly, letting their pets ruin the carpet and their kids draw on the walls. This isn't so bad if they buy the place, but it's quite bad if they don't. Fortunately, one of the benefits of renting a house to someone who plans to buy it is that, generally, they treat it much better than they do a place they believe they'll never own. In fact, some people may treat your home better than you do.
And so if you choose the right tenant -- and especially if you write up the right contract -- as Rick famously said in Casablanca, this could be the beginning of a beautiful friendship, or at least a great landlord-tenant relationship.
It’s easy to forget that part. After all, you are selling your home -- granted, a little slower than you initially expected. You might easily think that you’ll move out, people will move in and you won’t see them again until two years later at the closing. That could happen, but it probably won’t. If your renters want to refinish the basement, if the contract is what it should be, they need to get your permission first, and you have to grant permission. If there’s a leak in the roof or mold in the walls or some other structural damage, it’s ultimately your job to fix it, even if your contract states otherwise. Odds are something will come up over two years where you’ll engage in some landlord-type activity.
“Everyone getting into this has to understand that this is all subject to landlord-tenant laws,” says Vena Jones-Cox, a real estate broker and investor in Cincinnati who in the last 18 years has lease-optioned approximately 300 houses as the seller. “There are a whole bunch of laws out there, like lead disclosure. People will think, 'I don’t have to do that because it’s not a rental,' but it is -- all of those general laws referring to rental are applicable to you. Until the option is exercised, it is a rental.”
(That said, although the laws are slightly different, any home seller or landlord is required by federal law to disclose the presence of lead or other hazardous materials found in their home, if they know of its existence. After 1978, lead-based paint was outlawed for residential use.)
Vena offers another example. She says that in Ohio, where she lives, and in a lot of states, the water company will send the bill to the tenant of a house, but if the tenant doesn't or can't pay it, the homeowner is responsible. That can get expensive if the tenant owes four or five months of water bills, and it takes a while for the water company to tell you about it.
But that just underscores Vena's thinking on taking an evening class on property management -- and especially the importance of looking for a potential buyer who has a history of being a responsible citizen. These days, a low credit score doesn't automatically make someone a bad person or even a serious risk. On the other hand, you can't just give people the benefit of the doubt.
If you don’t stumble across a potential buyer going through the normal route of selling your home and decide you want to actively search for people interested in renting and later owning a house, you might check out iRentToOwn.com, which claims to be the largest marketplace for rent to own homes in the United States.
Here, you can list your house -- for a fee, of course -- and people interested in renting to own a home can search through the database. The site also has a wealth of information on real estate agents in each state who specialize in lease-options as well as other individuals and companies you’ll need on your side, like firms that do background checks and real estate attorneys.
“Essentially renting to own a house has been around for decades,” notes CEO and founder of iRentToOwn.com John Kobs. “But historically rent to own transactions have had a terrible track record. It’s generally been a seller taking advantage of an unsophisticated buyer. A lot of times you would see buyers where they would be a day late on their rent payment, and the seller would make them forfeit their entire down payment. There were a lot of incidents where people were even subleasing rent to own properties.”
What John and other real estate professionals around the country are trying to do in these desperate times for home sellers and buyers alike is create an environment where everyone wins.
Not that John's website is the only game in town. RentalHouses.com is worth checking into and, of course, your local newspaper’s classifieds and simple word of mouth among family, friends, co-workers and colleagues are always safe bets.
You are in good company. Presumably because of the poor housing market, some new apartment buildings and condominium developments around the country have been offering lease-options to their customers rather than going the traditional sales route.
The most important factor in doing this successfully is due diligence:
- Have a mortgage broker involved at the outset. If the mortgage broker reviews your potential buyer’s paperwork and feels that he or she will be a good candidate to buy the house in two years, you can feel reassured that you’ve done everything you can do to ensure a successful rent to own transaction.
- Have an attorney review the contract.
- Work with a real estate agent who has extensive experience with lease options.
As New York City-based financial planner Patrick Astre concludes, “It needs to be a fair deal, but it will never be a fabulous deal, and you’re not doing it because you’re going to get a fabulous deal. You have someone who is going to tie your house up for a couple of years, part of the rent’s going to be tied up in a deposit. But it is a good idea -- under the right circumstances.”