Advantages, Disadvantages of Rent-to-own, Co-borrowers
When it comes to having a home to live in, the concepts of buying and renting have their own fair share of advantages and disadvantages. For example, purchasing a home can be hard if you have poor credit and insufficient funds saved for a down payment, closing costs, and any necessary repairs. In contrast, renting doesn’t allow you to build equity, nor does it bring you any closer to being a legitimate homeowner.
However, there is another potential avenue to homeownership, and that would be the concept known as “rent-to-own,” which in many ways offers the best of both buying and renting in one package. But while the concept sounds all well and good on paper, is the reality of rent-to-own a good idea? This article will explore that question, as well as other potential alternatives to homeownership as well.
When it comes to rent-to-own, the concept is very simple: you enter into an agreement that allows you to purchase a home after spending a set period of time renting it. In this situation, the amount you pay in rent is typically more than the fair market value of the home itself; however, at the end of the lease the extra money that you have been paying essentially becomes the down payment on the house itself.
In addition, to secure the option of buying the house, an “option fee” – also called “option money” or “option consideration” – may be required to be paid up-front to the seller. It is the equivalent of approximately 2% to 7% of the home’s value, with the fee typically being negotiable to some degree.
The option fee secures the exclusive right to purchase the property for the buyer; however, it is nonrefundable and if for any reason you ultimately decide not to buy the home, you do not receive it back.
If you do decide to enter into a rent-to-own agreement, it’s important that you are secure in your decision. If at the end of the lease you decide not to buy the property – as mentioned above – you will not receive back the option fee, nor will you get back the extra money in rent that you have been paying towards the down payment throughout your stay.
There are numerous benefits to rent-to-own homes; chief among them is the ability to allow someone to improve their credit and save money for a down payment while getting to live in the home in question for an extended period to ensure they like it. The contract you sign ultimately determines the percentage of your rent that goes towards the down payment, and as stated above, the amount of monthly rent you pay in your lease will be higher than normal because of this.
Another advantage is saving money on repair costs, as typically rent-to-own homes split the financial responsibility for this between the tenant and the landlord. In addition, rent-to-own gives you a degree of flexibility in that when your lease is up, you have the option to either purchase the home or move on to something else if the experience of living there was not what you were hoping it would be, but with some degree of financial loss.
If you do decide to go forward with buying the home that you’ve been renting, you’ll need to contact a lending institution and acquire a home loan; from there, purchasing the property becomes a standard home buying process, albeit with the extra money that you have been paying throughout your lease going to your lender for the down payment.
While the concept of rent-to-own may sound all well and good, there are some cons associated with it as well. For example, as stated above, you will be out money if you choose not to purchase the home at the end of your lease; this alone is the biggest disadvantage, as you will forfeit the rent you have paid to the seller as well as the option fee, if one was required.
Also, depending on the length of your lease, you may not receive full credit for all of the additional rent you have been paying towards the down payment, as rent credit only applies to the previous 12 months. If your lease period is longer than one year, you will have to negotiate the purchase price to be lowered by the amount paid over the total life of the lease. Also, rent credit is dependent on the market rent at the time the buyer applies for the mortgage, based on an appraiser’s opinion; rent credit cannot be used if the market rent has increased from the time the buyer signed the lease if it is above the amount of the monthly rent.
Also, you will ultimately need to qualify for a home mortgage; if you are unable to do this, then you will not be able to purchase the property. If that is the case, you will lose all rights to the home and the seller can then either rent it again or put it on the market to be sold. With that being the case, it is important to make sure that, by the end of your lease, you are able to qualify for a home loan or the money that you have been paying will have been in vain.
There are two types of rent-to-own contracts: lease option and lease purchase. While both allow an individual to lease a home for a period of 1 to 3 years and purchase it at the end of that term, there are some important distinctions between the two that you should be aware of.
With a lease option agreement, you are required to pay the homeowner an option fee when the contract is signed; as mentioned above, that amount is typically between 2% and 7% of the home’s value. A portion of the rent money you pay goes towards your down payment if you buy the home, and more often than not, the option fee you paid will go towards the home’s final purchase price.
A lease purchase agreement works almost the exact same way as a lease option agreement; however, the major difference is that when you enter into a lease purchase agreement, you are obligated to buy the home when the lease is up, with the purchase price being agreed to with the seller when the lease is signed.
This contract option allows a buyer to know exactly how much they will need to borrow for a mortgage going into the arrangement, which allows them to start shopping for a loan much sooner. However, you will lose your claim to the home and the rent that you have paid into the down payment if you are unable to secure a mortgage by the time your lease is up. You also face legal jeopardy, as the homeowner will be able to sue you for breach of contract if you do not purchase the property.
It is important to note the rising popularity of what is known as adding a “co-signer” or “co-borrower” to the loan for another option; these are two similar terms that denote the sharing of the ownership of a loan with another party that assumes responsibility for payments.
The difference between a co-borrower and a co-signer is the degree of investment that they have in the loan. For example, a co-borrower has more responsibility and ownership because their name is on the loan, and as such they are expected to make payments on it from the start. In contrast, a co-signer only backs your loan and will not be obligated to make payments on it unless you are not able to do so.
Therefore, if you are having difficulty in purchasing a home, in addition to utilizing the rent to own concept, having a willing co-borrower or co-signer when the time comes to secure a mortgage can also help you on your way.
Ultimately, rent-to-own can be a good option for people who have less than optimal credit or who are having trouble saving money for a down payment. Rent-to-own is a good alternative means of achieving home ownership, but it comes with its shares of pros and cons and it is best to consult with an expert before deciding on a course of action.
