5 Mistakes to Avoid With a Rent-to-Own Home Purchase

Rent-to-own allows you to move into a house now and buy it later.

As interest rates rise, buyers become interested in alternative ways to finance a home purchase. One of these methods is referred to as rent-to-own, or lease option. Here's how it works: A tenant pays rent and the owner sets aside part of each month's rent to use as a down payment. The amount set aside for down payment varies, depending on how the rent-to-own contract is written. Once the tenant has enough money in their down payment fund, they buy the home, typically, by taking on a traditional mortgage loan. 

There are sometimes extra fees associated with rent-to-own home deals. For example, some homeowners charge an option fee of 2% to 7% of the home's value to "hold" the house until the tenant determines whether or not they want to buy after the lease expires. In addition, the monthly rent payment will likely be higher than standard rent in the area due to the extra amount going toward a possible down payment.

Properly researched and executed, a rent-to-own home purchase can work. The problem is the number of mistakes a person can make in the process. Here, we'll cover five of them and offer ideas that should help buyers get it right.

1. Not protecting your financial interest

The vast majority of rent-to-own deals take place directly between the homeowner and the buyer. That means almost no one has a real estate agent to walk them through the process. No matter how you feel about agents, that can be a recipe for disaster. A good agent looks for potential pitfalls and protects their client from financial fallout.

Because of the way commission structures are set up, it is the rare real estate agent who will become involved in a rent-to-own transaction. In fact, it may be impossible to find one. 

Going it alone means protecting yourself by:

• Learning everything there is to know about rent-to-own transactions before setting out to look at properties.
• Spending the money to hire a real estate attorney to look over your contract -- before you sign it.
• Working and reworking your monthly budget to ensure you can afford to rent and buy the property. 
• Doing your due diligence by hiring a home inspector before committing to a long-term deal. 

With no one else watching out for you, you must protect your own financial interests.

2. Becoming desperate

If you've been surprised by the limited housing inventory over the past two years, you may be even more surprised by how few rent-to-own housing options are available. Some are located in areas that may not appeal to you, while others may inspire bidding wars. In either case, it's important to keep a cool head.

Any time a product is scarce (whether it's toilet paper or housing), common sense is the first thing that flies out the window. If you find yourself feeling desperate to buy a house, consider pulling out of the market long enough to regain your composure. Here's a sample of what can go wrong when desperation drives your purchase decision:

• You may pay too much for the property.
• You may be willing to skip the vetting process.
• You may "fall in love" with a house and forget to protect yourself.
• You may send signals to the homeowner that you're an easy mark. 
• You may regret your purchase.  

3. Failing to negotiate

Let's say you move to a small town and find only one rent-to-own house on the market. Right away, the seller has the upper hand, particularly if they know you want the house. 

Now, imagine that other houses in that neighborhood appraise for $200,000 but the seller is asking $250,000 for their property, 25% more than neighboring homes. Whether it's a rent-to-own home or not, you owe it to yourself to negotiate like you would for any other property. Here's what you should ask for (at the very least):

• Have the home inspected so you know what you're getting into. Most rent-to-own home deals include a clause that calls for each party to pay half of all needed repairs until the time the tenant purchases the house. Still, why pay for half of all repairs when you could have requested some be made before move-in day?
• Make it clear that you want a home appraisal before purchasing the home. For example, it may be worth $225,000 today, but by the time you're ready to purchase, the value has dropped to $200,000. You need a current appraisal at the time of purchase, particularly if you're borrowing from a traditional mortgage lender. 
• Make sure there is a clause in the contract that allows you to walk away from the deal. In case the home fails to appraise for the agreed-upon purchase price, make sure there's a clause stating that you'll be refunded any money put aside for a down payment. If you paid an option fee, it's unlikely you will get that back. 

If the homeowner agrees and you decide to move forward, do not let up. You still have work to do.  

4. Letting your pride get in the way

When you're out there buying a home on your own, it may be tempting to play the Lone Ranger, to do everything independently. However, if you have a friend or family member who understands real estate or knows how to do home maintenance, invite them along to view the property with you. Their job is to tell you what you may not want to hear. For example, if the great old house you're looking at has a shifting foundation, it can help to have a friend remind you of how much trouble that foundation is likely to cause.

Don't be afraid to ask everyone you know for advice. Do you know someone who lives nearby? Ask them for the inside scoop on the area. Do you know a local teacher? Ask about the reputation of area schools as this information will be important to you later. 

5. Not giving yourself an escape hatch

Until the day you sign a rent-to-own agreement, you have the right to walk away. It doesn't matter how much time the homeowner "wasted" showing you the property or telling you about the neighborhood. Before you even begin house hunting, give yourself permission to walk away at any point in the process. 

You'd better believe that a great real estate agent would nudge you away from buying a property that's not in your best interest. You'll need to do that for yourself.

If you're ready to buy a home but want to wait until interest rates drop or until you have a significant down payment saved up, rent-to-own can work for you. Rule No. 1, though: Be prepared to advocate for yourself.