Why Rent-To-Owns Fail

A Rent To Own is an Agreement that involves a plan to move towards property ownership. 

The Agreement is usually between an Investor who owns a property and a Tenant. Unlike a standard lease agreement, a Rent to Own allows the tenant to have the “option” to purchase the property after a certain amount of time has lapsed for a predetermined sale price. 

Investors can use this strategy to sell their home for a very fair price while capitalizing on rental income and homebuyers can use it to buy time to work through issues that may prevent them from obtaining mortgage financing such as having bruised credit or an insufficient downpayment.

Usually, the tenant will have to put forward an upfront “premium” or a small part of what would eventually make up their down payment to purchase the property. Typically, at the end of the Rent To Own Agreement, the tenant can choose to purchase the property for the pre-determined sale price or not. 

How Does A Rent To Own Work: the logistics.

• House is listed for rent to own with an inflated monthly rental premium and an option to leave a small deposit. For example, some landlords will accept a 1-2% deposit of the pre-determined sale price. This premium and/or deposit is usually non-refundable.

 

• Tenants are usually asked to work with a mortgage professional and screen for credit, employment history, current employment and the likelihood of being able to purchase the home at the end of the Rent-To-Own Agreement. 

 

• The Tenant will then move in and the landlord will continue to collect rental payments. A lease is usually signed for the rental portion and a separate document is signed outlining the rent to own particulars. 

 

• A small portion of the monthly rental payments are set aside by the landlord or the rent to own company, if applicable, and later used as part of the down payment to complete the purchase. 

 

• If the tenant cannot fulfill their end of the bargain and does not purchase the house, they likely lose their downpayment saved and their rent credits.

Why Rent To Owns Fail...for Tenants.

Rent To Own Agreements have a high statistical probability of not working in the tenant’s favour, which is why they have often been considered lucrative business endeavours for investors willing to bet on the odds that tenants won’t complete the transaction. 

If tenants fail to purchase, their initial premium would be forfeited as well as the extra money they paid each month towards their down payment. 

Inflated Monthly Rent With A Portion To Act As A Downpayment 

Firstly, tenants are required to pay an inflated rental fee. A portion of it is saved by the landlord, and the accumulated money is set aside as their downpayment. 

What happens if the tenants cannot purchase the property after all?

One of the major disadvantages of "Rent To Owns" is the fact that should the tenants not be in a position to complete the purchase transaction as agreed,  the money that was set aside to act as their downpayment would likely be forfeited in addition to their initial premium. This practice has often undermined the benefits of rent-to-owns since tenants could walk away empty-handed while their landlord was able to turn a large profit.

Overcoming the reasons for agreeing to Rent To Own 

Most people who want to purchase a home know they have to save a downpayment in order to get mortgage financing. But more importantly than just savings, the reasons people enter rent-to-own agreements is to buy time to overcome difficult circumstances such as bruised credit, unemployment or income verification. All of these situations cannot be guaranteed to be fixed before the agreement date arises and can leave tenants at a major disadvantage and unable to fulfill their end of the bargain. Further, many tenants are unaware of lender guidelines and the hesitancy to approve financing of "rent-to-own properties. "

This largely has to do with what is considered acceptable forms of downpayment which must come from personal resources, gifted money, etc. If the landlord, who is the owner of the property is also giving the down payment back to the purchasers, this can disqualify the transaction altogether and often does.

Property Value 

Rent To Own Agreements can be as long as five years, which can create several opportunities for changes to the real estate market to affect property value. If property prices go up, then this could be a win for tenants. If they go down, however, tenants may find themselves in a position where they either have to buy an expensive, overpriced home or lose the money they put it into it by way of forfeiture. 

It is a Contract.

Tenants must not forget that a Rent-To-Own Agreement is a contract, and like any signed contract, all parties must uphold their end of the bargain. If not, legal action can ensue. It is imperative to have ALL contracts reviewed by a lawyer to ensure all terms are carefully understood and considered.

Mortgage Financing For Rent-To-Owns

Not all lenders will approve rent-to-own purchase transactions and this can create a lot of headache near the end of the rent-to-own agreement that may result in a failed successful purchase. It's a critical step in the process for anyone thinking of getting into a rent to own to verify prior to signing the contract whether or not they can get mortgage financing.

Sarah A. Colucci is a Mortgage Agent with Mortgage Edge 
She has extensive experience with Rent-To-Own Agreements. 
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