Buying a lease to own home could be the solution to getting your dream home even on bad credit
What happens when you find that perfect home, your dream home, but you just don’t have the money or the credit to buy it now?
You can either watch it go to someone else or take advantage of a home-buying option that could help save for a down payment while you get to live in the home.
The option is called lease to own or sometimes rent before owning and it could be your shot at the home of your dreams even if your credit score is a nightmare.
I’ve been on both sides of the table, as the buyer and the seller of a rent to buy home.
Buying a lease to own home isn’t like a traditional purchase so there are a lot of special considerations and potential pitfalls. Keep this guide handy to make sure you get everything out of your rent to own option.
How the Rent Before Owning Option Works
There are two very mortgage alternatives with a lease to own option so it’s crucial that you understand which you’re getting into before you sign any contract.
The first type of rent before you buy option is when you buy a home on contract. This is where the owner provides financing for the house so it’s another form of sale. You may or may not need a down payment and the interest rate is usually well above traditional mortgage rates.
Contract terms for buying a house this way usually last for five to ten years. At that time, you usually need to refinance the home with a mortgage to pay off the seller.
The other type of agreement is a lease option which is what we’ll be talking about for the rest of the article. Buying a home on contract has its advantages but it’s also been a way for landlords to get super-high interest rates out of tenants.
In the lease-to-own option, you’re still renting for a few years, but you lock in the option to buy the home.
The buyer agrees to rent the home for a few years and pays an upfront fee called the option money for the right to buy the house later. There are a lot of other important points in the contract but that option money is the most important.
The option money is a one-time fee and is usually non-refundable. You are paying for the right but not the obligation to buy the house. A lease to buy option agreement might go something like:
“For the sum of $6,000 payable on closing of this agreement, the seller agrees to give the buyer the right to buy the house at [address] for $200,000 at anytime for the next three years.”
For paying for that right, you can get financing and buy the house for a set price at anytime while you still have the option. There’s no standard rate for the option money but it’s usually between 3% and 5% of the purchase price of the home.
Expert tip: Negotiate to have the option money count as part of the purchase of the home if you decide to buy. That means if you bought the house in the example above, you would only owe $194,000 after paying the option money.
The risk is that you usually don’t get your option money back if you don’t buy the house within the contract time period. It might seem like a raw deal, why pay for just the option of buying something later and risk losing that money, but there are some great advantages for people with bad credit.
I’ve bought and sold houses on lease to own terms and the one thing I’ve learned is that you absolutely must negotiate all the sale details. It’s too late to negotiate when you buy the house in a few years and any holes in the contract can mean thousands in legal costs.
Checklist for Your Lease to Own Home Contract
Use this section as a checklist for your lease to own home contract.
You need to spell out every single one of these ideas because this is basically your home purchase contract you’ll be using in a few years. I haven’t had any legal problems buying or selling on rent to own terms but it’s only because I made sure my contract was super detailed.
Sales Price: How much will you pay for the house in a few years? You can determine a price now or agree to some calculation to use later. The fair price for the house can be determined later but don’t leave it up to the owner. Make sure the contract says an independent third-party appraisal will be used.
I always liked to lock-in the sales price as a buyer, to benefit from any appreciation over the years. As a seller, I wanted to wait to see what I could get later.
Rent: How much will rent be until you exercise the option to buy? What is the maximum rent can be increased each year?
Expert tip: Negotiate for part of your rent each month to go to a buyer’s credit that will lower the amount you pay for the house. Start by asking that $35 from the monthly rent be used as a credit and negotiate from there. This can be a great way to save up for your down payment.
Maintenance and Other Costs: Who will pay for maintenance and other home costs until you buy the home? You want to get the home in good shape but the landlord should have some responsibility to pay for repairs while you’re renting. Make sure to include in writing things like homeowners association fees, property taxes, insurance and maintenance.
Everything you need in a lease to own home agreement:
- Important dates including when you will start renting, when you can take the lease option to buy, when the option and your rental agreement expires, whether your option can be extended.
- How much is rent and what types of payment are accepted. When is rent due and is there a grace period? How are rent increases determined and is there a max increase percentage?
- How much is the security deposit and the option money? Are either refundable and under what terms?
- How may you use the home while renting including number of people allowed to occupy the house, pets and whether smoking is allowed.
- What inspection rights does the landlord have and how much notice must be given?
Make sure you spell out the responsibilities of big-ticket items for the house including heating & cooling systems, roof, foundation, homeowner’s and flood insurance, termites and pest control, plumbing & electrical.
Who Benefits with Rent to Own Homes?
With detailed contracts and lots of money changing hands, you always have to worry about who is getting the short-end of the stick.
But there is actually benefit on both sides in a good rent to own agreement.
As a buyer, you can lock-in a house that you might not be able to buy just yet. If you’re a good negotiator, you might even be able to lock in a price and make it easier to save for a down payment.
A lease to own home can be a great tool for homebuyers with bad credit. The three-year contract gives you time to increase your credit score to get approved for a purchase loan. Even if you have decent credit, increasing your score for a few years can help you get a lower interest rate and save thousands on your mortgage.
Home sellers in a lease option might be able to get a higher price or at least market value plus the option money. They also get a renter that is going to pay the rent on time and take care of the property as if it were their own.
How to Find Rent to Own Homes
Finding a home with a lease option available can be tricky. All the online real estate sites like Realtor.com and Zillow have search filters for rent to own homes. The supply usually isn’t much but it’s a good place to start.
There are also websites that specialize in helping find rent to buy options but these sites usually charge a membership fee. A lot of times you aren’t allowed to see the homes available until you pay the fee…and then you find out there isn’t much of a selection.
Instead, start with houses currently for rent. Spend some time finding a home you’d like to buy then ask the landlord if they would consider a least to own option.
This is where knowing all your options comes in handy because you’ll want to propose a deal that’s persuasive for the owner but still good for you as well.
- Find out what houses in the area are selling for per square foot to estimate a fair price for the house.
- Negotiate the rent lower by offering to pay some of the maintenance and other costs each month.
- Offer a high amount for option money but negotiate to use it as part of the purchase price.
Having a larger amount for option money can be a great way to get a landlord to agree to the lease to own option. Of course, if you had a big down payment saved then maybe you wouldn't need the option in the first place.
When I bought my house on contract, I borrowed the down payment with a personal loan from PersonalLoans. The site offers three types of loans including peer-to-peer lending for bad credit, personal loans and traditional bank loans so it's a little like shopping around for the best rates on one site.
Make sure you estimate your total monthly payment on the personal loan and the rent so you don't get into trouble. Since most personal loans are for three years, you can have it paid off before you go to get a loan to buy the house. The payments you make on the loan will also help improve your credit and help get the mortgage.
Check your rate today on a personal loan up to $35,000
Real estate agents can be another great source to find lease to own homes by talking to their sellers and within their network.
Disadvantages of Lease to Own Homes
There are a few downsides to rent to own option, for both the buyer and seller.
You have to get everything spelled out exactly in the contract and sometimes that isn’t even enough to avoid an expensive court battle. You may not want to spend the extra money but save yourself the headache and have a real estate lawyer or someone with experience in rent to buy contracts look over the details.
A lot can happen over several years and sometimes one side or the other wants out of the contract. This is harder with a strong contract but it still may wind up in court.
Shifty landlords can try to tear up the contract if you’re late on rent by more than a few days or with any other minor failure in contract terms. Some states have laws protecting tenants but it’s still best to get all the details in writing. When in doubt, stand up for your rights.
Buyer’s Process for Lease to Own Home
We’ve covered most of the detail that needs to go into your lease to own contract but here’s one last checklist to make sure you get everything down and a process to follow.
- Make sure you check the seller’s credit for warning signs that might lead to them losing the house before you get a chance to buy it. This can include large, unpaid debts and other delinquent accounts.
- Get a title report for the home so you know who actually owns it.
- Get an independent appraisal and inspection of the home before negotiating sales price and other terms.
- Talk to a mortgage broker or bank to see if you can just buy the house now.
- Negotiate price, rent credits, down payment, option money, terms for extension and other rights with the owner.
- Even if you negotiate a rent credit to count towards your down payment, save a little extra each month. The more you can save, the more likely you’ll be able to get a loan for the house.
- Keep track that the owner is paying property taxes and mortgage payments while you’re renting.
A lease to own home option can be a great tool for bad credit borrowers not able to get a loan they can afford just yet. It can give you time to rebuild your finances without letting that dream home go to someone else. Watch out for some of the problems in rent to buy and you’ll be the proud owner of your dream home in no time.
About the Author
Joseph Hogue is a financial expert and investment analyst. After serving in the Marine Corps, he started his career investing in real estate before becoming an investment analyst for some of the largest private investors. He's appeared on Bloomberg and on CNBC as an investment expert and has published ten books in personal finance. Now he helps investors reach their financial goals and invest in the stock market with some of the same advice he used when working for the rich.