A well-advised, clearly written agreement is key to a successful rent-to-own deal. A rent-to-own contract, also known as a lease-option contract, can be a great way for a credit-challenged renter to become a homeowner. However, rent-to-own transactions are more complicated than traditional home sales and can lead to legal battles and financial losses if you aren't completely clear on the risks and rules before you enter into an agreement. A real estate attorney, real estate agent and mortgage lender well versed in lease options can prepare you for a smooth transition into home ownership.
Carefully Consider Rent-to-Own Terms
Provisions of a lease-option contract vary. What may work for one buyer and seller may not work for another. To avoid misunderstandings, be sure you understand all terms outlined in a rent-to-own contract before signing. For a fee, a real estate attorney can review a contract and revise terms as deemed necessary, helping to safeguard your legal interests.
The initial stage of setting rent-to-own conditions may require negotiating if you don't agree with a seller's predrafted contract. A real estate agent with experience in lease options can also help you set reasonable and customary terms for the rent-to-own contract and negotiate a fair rental and sale price with the seller.
Basics Terms to Include in the Contract
A rent-to-own contract should include several key terms:
- Home price you will pay if you decide to buy at the end of your rental term.
- End date, or time frame, for exercising your option to buy the home.
- O**ption fee**, typically equal to 1 percent to 5 percent of the sale price.
All or part of the fee goes toward your down payment or closing costs
when it's time to buy the home.
- Payments required in addition to rent. For example, in rent-to-own contracts, it's typical for renters to assume maintenance responsibilities.
- Renegotiation options of the sale price if home values fall before you buy the home, as this can impact your ability to get a mortgage and follow through with the purchase.
Your bad credit may take months or years to fix. Therefore, make sure that you set a realistic time frame for repairing credit and qualifying for a mortgage.
Determine the Right Rental Price
A real estate agent or home appraiser can help you decide on a fair rent amount. Each month you will pay an amount above fair market rent known as a premium. Premiums go toward the purchase price, or you forfeit them if you decide not to purchase. Knowing the home's fair market rent value is important because if you pay too much in rent, you may lose out on money that you could have applied toward your future purchase. An agent can research rental values in the area for free, or you can pay an independent appraiser to generate an official fair market rent appraisal.
According to Bankrate, the lender may ultimately determine the amount of the rent that will go toward the down payment or closing costs on a mortgage. It's usually the difference between fair market rent and the agreed-upon monthly rent. Speak with a mortgage lender before entering a rent-to-own contract to understand undewriting guidelines that will apply when you buy.
Make Mortgage Preparations and Repair Credit
A mortgage lender can let you know how much improvement your credit requires by telling you the minimum credit score needed for the home loan you want. The lender can also estimate the down payment amount and closing costs you can expect based on current underwriting requirements. However, figures and requirements are subject to change depending on mortgage conditions and interest rates when you buy.
Increase your credit score by fixing or removing any fraudulent or incorrect information from your credit report. You can do this yourself for free by contacting the credit reporting agencies -- Equifax, Experian and TransUnion -- and showing proof of the error. In addition to improving your credit, your income and employment must remain stable and consistent to obtain a mortgage one or more years down the road.