I described, you should be able to buy your next home on a rent-to-own basis.
In the next chapter, we’ll get into some of the nitty-gritty details about how rent-to-own works.
Chapter 2:
How Does Rent-to-Own Work?
There are many pieces to the puzzle that fit together to make a rent-to-own transaction.
Understanding Rent-to-Own
In Chapter 1, I was deliberately vague about how the rent-to-own process works so you wouldn’t get bogged down in the details. It’s time now to get into some of those details so you’ll have a deeper understanding. We established that a rent-to-own transaction between a buyer and seller will consist of the contracts, an agreement on price and terms, an option fee, a rental period and the end sale. Let’s look at each of those parts now. If you have already decided that this is too much for you, then give this book to your Realtor®. If you need a Realtor® who understands rent-to-own, please email my office at [email protected] and I will refer you to an agent well-versed in rent-to-own. Let’s jump into the details.
How Rent-to-Own Transactions are Structured
The Contracts
In any real estate transaction, contracts play a vital role. They define the rules of the transaction. A rent-to-own sale is no different, although there is a bit more paperwork required to cover the different aspects. The three contracts needed in a rent-to-own transaction are the Rental Agreement, the Option Agreement and the Sales Contract. I’m going to give you a brief overview of each contract here so that you have a better understanding. We will look at each one individually in even greater detail in Part 3: “Understanding the Paperwork”.
Rental Agreement
The Rental or Lease Agreement is very much like the lease agreement when renting an apartment or home. It defines the term of the lease, dictating how long the renter can live in the property as well as the amount of monthly rent and security deposit. Additionally, all of the other general rules and conditions of the lease are covered, such as the number of people permitted to live in the property, whether pets are allowed, how many cars, how repairs are handled and so on.
Option Agreement
The Option Agreement or Option to Purchase Agreement gives the tenant-buyer the right to purchase the home from the seller at a later date. It specifies how long the option agreement is valid. It states how long the tenant-buyer has to execute the purchase and close on the home. The option agreement usually does NOT specify the purchase price or terms of the purchase. It does, however, specify the amount of the option fee and whether there is a monthly option credit (option credits are an agreed upon amount that will be credited toward the purchase price should the renter purchase the property as agreed).
The Option Fee is what makes the Option Agreement valid; however, it is not 100% necessary to make it valid. Remember, option fees are non-refundable, but security deposits are refundable. Signing the Rental Agreement, which is a promise to pay (like a promissory note), would also be valuable for enforcing the option. As the buyer, you will want your option fee to be as little as possible (or only pay a security deposit), giving you less of a risk.
Sales Contract
The Sales Contract or Purchase Agreement is the document that covers the details of the purchase of your home. It includes the purchase price and what non-permanent features of the home are included in the purchase; such as the appliances, furnishings or the gorgeous 1965 Mustang convertible in the garage. It specifies how the home is to be paid for at the end of the option time period; either a mortgage or cash sale. Okay, it probably won’t be cash so don’t get too worried! The Sales Contract also specifies all of the other terms and conditions of the actual sale. For instance, how the property taxes will be prorated, whether the buyer will have a home inspection, etc. In this case, it is a rent-to-own transaction so the Purchase Agreement also notes that it is part of the Option to Purchase Agreement; thereby binding them together.
The Terms
In addition to the paperwork, which defines the details of the transaction, there are some terms of the agreements that are quite particular to rent-to-own transactions. In addition to being unique, they are extremely important. The terms cover the different financial aspects of the transaction, which can greatly affect YOUR bottom line.
In Chapter 11 - “Key Points to Negotiate – Not All Deals are Created Equal”, we will cover how you can negotiate these terms to make the deal better for you. They are:
Monthly Option Credit
As we mentioned, this is a portion of the monthly rent credited towards the purchase price ONLY if the tenant-buyer exercises the option to purchase. This credit is in no way mandatory, but can be very helpful to the buyer when it comes time to purchase. As the buyer, you will want to get as much in option credit as possible.
Monthly Rent Amount
Typically, rents are priced at market rent or a little bit more on a rent-to-own transaction, however, this amount can always be negotiated to make it better for you.
End Purchase Price
The amount the buyer will pay for the home once he exercises the right to purchase. This final amount will determine the buyer’s new mortgage payments. Here are some factors you should consider when deciding what to offer for the house.
•It’s a rent-to-own - Some rent-to-own sales may command a slightly higher purchase price; possibly as much as 5 to 10% more, depending on the strength of the real estate market in that area. As the buyer, of course, you don’t want to pay more than market value; you really want to get a deal on your new home.
•Items that are included in the sale - Items such as appliances, furnishings, pool tables and other properties all have monetary value. If you include the refrigerator, stove, dishwasher, washer and dryer in the purchase, you can be adding thousands of dollars worth of value. Don’t overlook the value of these items when determining the purchase price you will be offering.
•Who will make repairs - Who will be responsible for repairs during the rental period? Every repair costs money. If the home ends up needing a big-ticket item such as a roof or a furnace, it will be expensive. This is a point you can negotiate with the seller. This will be discussed in detail later in the book.
•Closing costs - The costs associated with the sale of the home, such as title insurance, mortgage origination or points, payment to the closing agent, etc. can be quite expensive. It is fairly common to include part of these costs in the mortgage to help reduce the amount
