If you are planning to own your dream home but you are not qualified for a traditional mortgage yet, you might have heard about the option of getting a rent to own home. But what does rent to own actually mean? How is it different from a typical rental or from a mortgage? Is it possible to get a rent to own home even if you have bad credit?
In this article, we will give you an overview of how a rent to own program works and if it is a good idea for people with bad credit. We will also list down some advantages and disadvantages of this type of home-buying process. By knowing about these things beforehand, it could help you decide whether a rent to own program is for you.
What Is Rent To Own?
A rent to own or lease to own program is a method of home ownership wherein you go into a rental agreement first and then after the duration of your lease contract, you can buy the house. Unlike a traditional rental agreement, a rent to own agreement gives you the right or option to buy the property. Additionally, you could also have a portion of the monthly rent applied to your home purchase cost.
There are two kinds of rent to own agreements: lease-option and lease-purchase.
In a lease-option agreement, you will have the option to buy the home after the duration of the lease but you do not have the obligation to do so. For example, if your lease duration is five years, you can have the choice of whether to buy the property when you reach the end of five years.
In a lease-purchase agreement, on the other hand, you are obligated to buy the property after the end of the lease agreement. Whether or not you have money at the end of this contract period, you could be legally obliged to still purchase the house. If you cannot do so, you may lose all the payments that you have made.
How Much Of Your Rent Will Go Into Your Home Purchase Cost?
This is one of the most popular questions when it comes to rent to own homes. Some people think that all or majority of the monthly rent will go into the purchase cost, however, this is a very false assumption.
A rent to own agreement is unlike a traditional mortgage where the monthly payments go towards your purchase cost. In a rent to own agreement, only a portion of your rent is applied against the purchase price should you decide to buy the house. The exact portion of the rent that will go into buying your home will depend on your agreement with the owner. This can range from 10% to 25% but as mentioned, this will depend on your rental agreement.
Can I Qualify For Rent To Own If I Have Bad Credit?
According to Experian, if you have a credit score of 700 or above, this is generally considered a good credit score. But what if your score is below 700? Will you qualify for a rent to own home? The good news is that you could qualify for a rent to own home if your score is at least 620. If your credit score is below 600, it will be difficult for you to find a rent to own agreement with fair terms.
If you find a rent to own agreement that is too good to be true like having no down payment and no credit check, make sure that it is a legitimate rent to own program for people with bad credit. Read all the fine print or invest some money in a real estate lawyer. Many people with bad credit fall into rent to own scams and end up paying more than what they should only to find out that it is not possible to buy the house at all.
It may be more logical to wait it out instead of rushing into a suspicious rent to own agreement. Use this time to raise your credit score until it reaches above 620 before considering a rent to own home. This way, you can have more options when choosing a home. You may even qualify for an FHA loan or a traditional mortgage.
Below are some quick tips to raise your credit score fast.
- Use a secured credit card to build your credit history.
- Make timely payments on your bills.
- Keep your credit card utilization below 30%.
- Dispute hard inquiries on your credit report. You can also dispute errors and other negative entries.
What Are The Pros And Cons Of Rent To Own?
Getting into a rent to own agreement has its upsides and downsides. Below are just some of the common pros and cons of a rent to own home.
Advantages of a Rent to Own Agreement
- You can have a chance to start the process of owning a home even if you do not qualify for a mortgage.
- You can immediately move into the house on the agreed move-in date. In a traditional mortgage, you will have to wait for one to three months before you can move.
- If you have already decided that you want to live in a particular house, a rent to own agreement buys you time so you can “lock in” that house for the duration of the lease contract. You avoid the risk of losing the house you want to another buyer.
- Buying the same house you’ve rented means you can stay in the same neighborhood, save money on moving costs, and continue enjoying whatever improvements you’ve made on the house.
- A rent to own home with a lease-option can provide you with the opportunity to test out the house first and the neighborhood if you are not sure yet if you want to commit to it forever. You can back out and buy another house after the lease contract has ended.
- If you have bad credit, you can have a chance to improve your credit standing while you are already living in the home that you like. This can help you qualify for a mortgage when the lease contract is completed.
- Compared to just renting, some portion of the monthly rental can go into your purchase price which could make it easier for you during the home buying process.
- In some cases, it may be possible for you to lock in the purchase price of the house at the beginning of the lease agreement. This is especially advantageous if you’re buying in a neighborhood where house prices historically rise up significantly.
Disadvantages of a Rent to Own Agreement
A rent to own agreement may sound too good to be true but in reality, there are several disadvantages that you need to be aware of.
- While a rent to own agreement does not require you to pay a huge down payment, you may have to shell out a fee to have the right to purchase the house at the end of the lease contract.
- After the lease contract is completed and it’s time for you to decide whether you want to buy the house, you still need to qualify for a mortgage and pay a down payment. If you still have bad credit after the lease agreement and you don’t qualify for a mortgage, you may end up losing the right to purchase the house.
- If you have locked in a purchase price for the house at the beginning of the lease agreement, there is also the risk of the value of the property going down in case of a housing market crash or crisis. You could end up paying more than what the house is worth.
- The monthly rental price in a rent to own agreement is typically higher than normal market rates so you have to check whether the amount going to your house purchase cost is higher than what you are paying extra. For example, if the normal rent price in the neighborhood is $1,500 a month, the house owner may charge you $2,000 a month in a rent to own agreement. If only $300 a month out of the $2,000 is applied towards your house purchase price, then it may be better for you to save the extra $500 yourself.
Things To Consider Before Signing A Rent To Own Contract
Before you sign up for a rent to own agreement, it is important to do your due diligence on the property. Follow these tips to avoid common mistakes of people getting a rent to own home.
- Check whether the agreement is lease-option or lease-purchase. A lease-option is better for you if you are uncertain whether you want to buy the house. On the other hand, if you’re dead set on buying the house, a lease-purchase agreement with a purchase price locked in can protect you from the owner raising the purchase price or from other situations that may prevent you from buying the house.
- Check the rental price of similar homes in the area and compare it with the price of your rent to own payment. This way, you can weigh whether it is more logical for you to save the difference in the cost rather than paying higher-than-market prices.
- Review the contract to see who will be responsible for maintenance during the duration of the lease. Major repairs like fixing the roof or plumbing can be expensive and you could be at a disadvantage if you have to shoulder these repairs.
- If you have bad credit now, evaluate your finances carefully before getting into a rent to own agreement. Will you be able to raise your credit score during the lease contract so you can qualify for a mortgage when the lease is up? Not qualifying for a mortgage means you may lose the fees and money that you have paid. Again, read the fine print of the contract whether you can get a refund, but in most cases, you won’t.
Getting a Rent To Own Home With Bad Credit
If you have bad credit and you can’t qualify for a mortgage, you might have a better shot with a rent to own home. However, you would still need a credit of above 620 to qualify for most rent to own programs. Consider raising your credit score before committing to a rent to own deal to widen your options.
Aidan has been writing about personal finance for over 6 years. Prior to this, he worked as a Corporate Finance Analyst where he specialized in Due Diligence, Company Valuations and more. He is a CFA charterholder.
