While overall low inventory has led to competition in some markets — about a quarter of 2017 home sales yielded sales prices higher than the asking price, according to Zillow — it’s a different story for some sellers.
The median asking price, $256,000, is higher than the median accepted offer: $229,200. And if you’re in a softer housing market, the home you’re trying to unload could sit far longer than the national average of 80 days.
For sellers, even if it’s not the first choice, a rent-to-own arrangement can yield positives: steady monthly income while moving toward the promise of a sale. For buyers, it can mean having a place to plant roots while working toward purchasing the home they’re living in.
There can be a variety of reasons a buyer cannot purchase a home outright, said Martin Orefice, founder of rentoownlabs.com. For instance, someone might be unable to qualify immediately for a mortgage due to credit issues or short work histories. Or, they might need more time to save for a down payment but want to get in a house and stay put.
“The situations where it doesn’t work well is if the buyer has no credit, no steady work and they think about it the way they’d think about renting-to-own, say, a couch,” Orefice said.
While both parties need to watch out for ill-intentioned people, doing your due diligence is part of approaching a rent-to-own situation so it has the best chance of working out favorably for both the buyer and seller. Realtors and title companies often have standard documents to work from for these arrangements.
Here are some aspects to consider.
In simple terms, a rent-to-own arrangement involves two separate agreements: one for the rental period and one for the purchase.
“They are two different documents that are tied together, outlining a common purpose,” Mendenhall said.
Basically, the buyer agrees to rent the house for a set amount of time with the right (or expectation, depending on how the contract is written) to purchase the home at the end of the rental time.
Like any rental contract, your agreement should include the monthly rental amount, who has responsibility for repairs and maintenance during the rental time, and what rights both the landlord and renter have.
For instance, the homeowner needs to be able to evict the renter if terms of the rental agreement are not met. Likewise, the renter needs to know exactly under what circumstances an eviction could happen.
The length of the rental portion varies. Typically, they range from 12 to 36 months, Orefice said.
“I usually encourage people to rent for longer, because you want to have as much time as possible to make the purchase go successfully,” he said.
This purchase part of the contract will specify either an agreed-upon purchase price — which can be higher than the current market value, depending on the length of the rental agreement — or include details of when and how the price will set in the future.
If you are the seller, it’s important you assess the buyer’s ability to purchase the house by the pre-planned date.
To do that, start by verifying their income and work history. The general rule is that no more than a third of income should go toward housing, Orefice said.
Also confirm that the buyer has a plan in place to save enough for a down payment and closing costs and to fix any credit issues that could stand in the way of qualifying for a mortgage.
If you are the buyer, you need to make sure that the seller is indeed the owner of the house and that there are no outstanding liens or judgments against the property that would interfere in transfer of ownership.
Additionally, you should have the home inspected just as you would any home you are thinking about buying.
Sometimes, the seller will ask the buyer to pay what’s called an option fee. This chunk of money, which amount can range from almost nothing to up to 5 percent or 10 percent of the purchase price, gives the seller the exclusive right to purchase the home.
If the buyer walks away after the rental period, the option fee is typically forfeited. If the buyer follows through, the money goes toward the purchase price.
Buyers should make sure under what circumstances this fee could be forfeited during the rental portion of the deal.
Orefice says to read the contract carefully, because it could state that if rent is paid more than a set amount of days late — sometimes as little as 10 days — the option fee will be forfeited.
One common aspect of a rent-to-own arrangement is for a portion of the monthly rent to go into an escrow account until the date of purchase, at which point the saved-up amount is used toward closing costs or a down payment. If the buyer walks away, the money is forfeited.
In these cases, the rent is higher to accommodate that escrowed amount. For instance, if the rent is $1,000 monthly and the tenant pays $1,300 each month, that extra $300 would grow to $3,600 after 12 months or $7,200 after 24 months and go toward the purchase.
Orefice said he’s also seen cases where the seller matches the monthly escrowed amount for the buyer.
“As the seller, you want the person who’s renting to be able to buy your house at the end,” Orefice said. “Having a bigger down payment available can help them do that.”
Make sure it’s clear who is insuring the property. Even if the seller continues paying homeowner’s insurance during the rental, the tenant should have renter’s insurance to protect their belongings.
Likewise, make sure the rental portion of the contract outlines exactly who is responsible for maintenance and repairs on the property.
Orefice said it can make sense to have the tenant responsible for repairs up to a set amount — $200 or so — and the homeowner taking on more expensive repairs.
“Part of that is getting the buyer in the mindset that this is going to be their property and they need to treat it as such,” Orefice said.
More from Personal Finance: