Home > Mortgages > The Pros & Cons of Rent-to-Own Home Deals

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That age-old question when choosing a place to live of rent versus buy actually raises a series of questions. What can you afford? What makes sense for your situation? Can’t I just live with my parents forever? No matter which aspect plagues you most, it seems there is actually a middle ground.

Once you know how much house you can afford (here’s a calculator to help), you might be tempted to investigate rent-to-own options in your range. These arrangements can benefit both the seller and the buyer, but they do not come without risks. If you are thinking of a rent-to-own deal, check out the process, pros and cons below.

How It Works

Rent-to-own arrangements pretty much work like they sound. Instead of applying for a mortgage loan as you do when buying or renting without building any equity in the property, you do a combination of the two. The renter/buyer pays the landlord/seller directly and part of the rent is applied to the principal on the home – eventually adding up to a kind of down payment.

The buyer and the seller create a contract that specifies the purchase price of the home, the monthly rental rate and length of the rental term. The seller may also require that the renter/buyer pay property taxes, insurance and any maintenance costs. Once the rental term is over, the renter usually can buy the home for the difference of the amount paid so far in rent from the purchase price previously agreed upon.

The Benefits

This can be an option for homebuyers who do not qualify for a traditional mortgage. You don’t need to have great credit or enough cash saved up for a down payment. (You can check your credit scores for free on Credit.com to see where you stand.) In fact, renting to own can give you time to build income and improve your credit history. This arrangement also allows an escape plan in case you decide the neighborhood or home isn’t for you or even if the property value drops drastically over your rental term. Keep in mind, however, that entering into a rent-to-own agreement isn’t as easy to break as a lease and you will most likely lose the equity you’ve been building (more on that below).

Sellers benefit because they have an eager renter who will likely take better care of the home than a standard tenant. They also get steady revenue and don’t have to pay closing costs until purchase time.

The Drawbacks

Remember when I mentioned that you can leave if the house isn’t working out? While it seems like a pro, this can also be a con because if you decide not to buy at the conclusion of your rental term, you will likely lose the investment or the “down payment” fund you have created. Most contracts dictate that the seller retains any principal payment you made regardless of whether you go through with the home purchase or not. At the end of the arrangement, you could face the same challenges that held you back from buying in the first place — like a lack of a down payment or bad credit.

If you decide to move forward with a rent-to-own agreement, it’s important to read the contract carefully and understand what you are getting into before you sign on the dotted line. You may want to discuss with a real estate attorney or financial adviser before committing to this kind of deal.

More on Mortgages & Homebuying:

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