rent-to-buy…how does that work?

This morning a client wrote to ask about rent-to-buy. She is currently in  the second year of a two-year lease on a single family house in Hamilton. The house is working for her and her children and the owners are settling into their new home out of state and will not be coming back to Jersey. However, my client cannot qualify to buy the house right now; she needs some time to clean up her credit and save for a down payment and closing costs.

rent or buy sign

Sounds like a perfect situation for a rent-to-buy arrangement, doesn’t it? My client would have peace of mind knowing she will eventually be the homeowner, and will not have to search for a new house to buy, or move her family again. Sellers would breathe easy knowing the property, while not yet sold, is at least under contract to be sold at some future point.

In my eight years in the business I have had many people inquire about rent-to-buy, but I’ve never actually seen a rent-to-buy arrangement agreed to and signed. That’s because rent-to-buy is not a good deal for buyers or sellers.

First, why should a buyer contract to purchase a property at a particular price at a future point in time, not knowing what the fair market value for the house will be at that time? This is obviously only smart if prices are going up and expected to keep going up, which would allow you to lock in today’s prices to be paid in tomorrow’s dollars. But in a stable or still declining market, no buyer should commit to pay today’s prices for something that tomorrow could be worth less.

Also, many people believe that all or most of the rent paid in a rent-to-buy arrangement can be applied toward the eventual purchase of the property. Actually, only that portion of the rent above and beyond the fair market rental value of the property can be applied to the purchase. In other words, if you’re paying $1,800/month rent, and that’s fair for the market, you would have to pay MORE THAN $1,800 each month, and then only that portion above the $1,800 could be applied to your future down payment.

It’s like having a non-interest-bearing forced savings account, but why would you want that?

From the seller’s perspective, the deal is no bargain, either. Psychologically speaking, the house is sold-but-not-sold. It’s still the seller’s property should maintenance be needed. There’s a signed contract, but the closing date is so far in the future that anything could happen. As a condition of the rent-to-buy contract, the seller has probably agreed not to show the house to anyone else during the tenant/future buyer’s residency, so he’s foregoing any potentially better offers he might have attracted during this period.

And let’s say you get to that moment in time at which the contract says title will be transferred at the price agreed to many months in any deal, if an independent appraiser determines the property is worth less than that contracted sale price, the buyer will of course refuse to pay more than the appraised value and the seller won’t be able to force her to pay the (higher) contracted price. So the seller is not “locking in” the price at all.

Rent-to-buy sounds good but in practice it doesn’t work for buyers or sellers. If you are a buyer without much cash for a down payment and closing costs, there are better ways to buy a house than rent-to-buy. I will be talking about two of those ways, USDA home loans and HUD’s 203(k) loans, later this month.

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