Monday, February 6, 2012
Do you know what "Rent with option to Buy" means or entails?
A number of people, mostly people who don't own homes, have mentioned to me that they would like to be in a "rent with option to buy" situation. I am enough to say that I learned a lot about "rent with option to buy" from Jody Beal, the property manager for Weichert Realtors in Washington, DC. My office was fortunate enough to have her speak a couple of weeks ago at a meeting. I have had a couple of follow up conversations and emails with Ms. Beal to make sure I have a pretty good grasp on this subject so I can have more thoughtful discussions when people bring this topic up with me.
What is "rent with an option to buy" and is it good or bad for me to enter into one of these arrangements (whether I am the renter or I am the home owner.)?
So, I wanted to share with you a few things I learned and by all please check with a property manager and/or real estate attorney before agreeing or disagreeing to a "rent with option to buy" proposal.
There are several reasons why people want to have an option to buy a home that they will rent and I am sure that below doesn't cover very possible scenario. But, it gives you an idea as a possible renter and a possible home owner.
One reason why renters want to have a lease with option to buy because it is holding a carrot of possible ownership. They want to have in writing "the American dream" of home ownership. So, why don't they just buy a house? For some it is because they don't know the neighborhood well and want to make sure they like the neighborhood before buying in the neighborhood, but they want this house just in case they decide it is the right neighborhood for them. The question I sometimes ask myself is why don't you just rent (without this option) and/or what if another home comes up that you like better when you are under this lease with option to buy agreement. I will address this in a little bit.
Another reason people pursue this option is because they don't have good credit, a good debt to income ratio and/or they can't qualify for a high enough loan amount, so at this point they can't buy. But they want to hold onto the dream of buying if a home owner will agree to a rent with option to buy. But the question that begs to be asked is if they don't have good credit or a good enough debt to income ratio, how are they going to improve their debt to income ratio by paying a premium for this option to rent? Does paying this premium increase the ratio?
Another possible reason people may want to rent with an option to buy is because they have a job and aren't sure how long the job is going to last. Perhaps the job is a contract and there is a possibility that it can turn into something "long term" at which point a person would want to go forward and buy the house. They may really like the house and want to be able to buy it as soon as their employment situation is clearer.
The last reason I will mention is that people may be in a transitional state of a relationship. Perhaps they are engaged and don't want to purchase the home until they are married or if G-d forbid they are through a troubled relationship and want to resolve the issues, make sure they are in a good committed relationship before buying a(nother?)home together.
Things to consider if you are a home owner and a person approaches you about renting with an option to buy:
When somebody approaches you and says they want to rent with an option to buy, they are basically telling you (and they may know this or not know this already)is that you cannot sell your home to somebody else besides the renter as long as the rent with option to buy contract/clause is still valid. You are in an exclusive relationship, almost promising to get engaged to somebody or you are engaged to somebody until the right time comes that you are both willing, able and desire to go forward.
As an owner,because you are being asked for this exclusive relationship, I suggest a couple of things to ensure that the people renting are financially vested and that it isn't just you being tied down to them. You should derive a benefit.
The first thing I would suggest is charging a slightly higher rent since you cannot market your home to sell to anybody else if you decide you no longer want to own the home, if it is within option to buy period of a contract. Should you go forward to a purchase,then you will apply the premium charged above the rent cost to the renter's closing costs for purchasing the home. The second thing I would do is charge a significant fee, perhaps 3% of the agreed upon sale price to enter into a rent with option to buy contract. This 3% will be applied to the purchase, but if the renter decides in the end not to purchase the home, is unable to purchase the home at the end, that 3% is the home owner's money, since the owner was locked into a possible purchase with the renter to the exclusion of anybody else during the option period.
The owner and the renter should draw a contract specifying how long this rent with option to buy period lasts. For the renter, the longer the time period the better and for the home owner, the shorter the time period the better so he doesn't have to worry about being locked in if it becomes evident that the renter cannot go through with a purchase.
As a home owner, again, you should insist on a significant fee,perhaps 3% of the sale price from the renter that gets escrowed, to give you some assurance that the people renting are actually serious...financially vested and have demonstrated a financial ability to be able to buy, but they don't want to buy the house yet.
There is usually a separate contract for a lease and for the potential purchase at an agreed upon price or the renter and owner agree to send out a couple of appraisers and take the average number as the price.
Sometimes in a rent with option to buy scenario, since the renter cannot go forward with purchase of home at the time but has every intention to, the renter and owner agree that the owner will make repairs but when it is time for certain things to get replaced, perhaps a toilet or oven, that the renter will pay for the new item since in theory this is going to be his/her house and he/she should then choose the type of appliance. This could be a negotiating point.
Something that home owners in a rent with option to buy scenario should watch out for is as the lease period comes closer to the end, the renter may be asking for bigger repairs on items that don't actually need to be repair, but they are old. For instance a renter might be trying to get out of buying a new roof in the first couple years of ownership,so he/she might say there are roof problems and the roof needs to be replaced. It is possible that the roof needs to be replaced, but I would bring out a contractor or home inspector to assess the roof, if it is damaged or not before saying yes or no. But this is why the idea that a landlord in a rent with option to buy scenario takes care of normal repairs and the renter takes care of new items for the home.
Some advantages of renting with option to buy:
*Helps buyer build down payment if owner and renter agree that portion of rent be applied to down payment if renter buys
*Again, owner of home could let renter make improvements to home to his/her liking since renter wants to buy home. Owner will still take care of standard maintenance,repairs as a landlord would
*A renter gets to know a neighborhood prior to buying...but on the other hand you don't need rent with option to buy in order to do this
*Helps renter build credit history so lender can approve you for a loan. The question though is that buy paying a premium for a rent with option to buy option, aren't you increasing your debt to income ratio?
Some disadvantages of rent with option to buy:
*A landlord may charge higher than market rent since as condition that part of that rent would be applied to down payment.
*You may lose your down payment, the 3% up front fee (or whatever you agree to) if renter decide not to go through with the purchase.
*Most of the time rent with option to buy don't come to fruition so the renter could lose a lot of not refundable money and the home owners could lose an opportunity to sell the home to somebody else (even if that person offers better terms!).
*You may want to check with a lender on the amount of closing help a home owner can give you when you buy the home...in other words, what if the lender won't allow the down payment and/or additional money applied from rent to be applied to the buyer closing help with the type of loan you want?
*As a renter,you want to make sure the owners are motivated and cooperative in doing repairs for items in the home, as he or she would in a "traditional rental situation".
By the way,if somebody has recently put their home on the market for sale, the chances are slim that he or she wants to be a landlord,which is what you are asking them to do with a rent with option to buy. My suggestion is to bring up this possible scenario to people whose homes have been on the market for a long time and haven't sold. Sometimes the listing remarks for homes say, rent with option to buy. Some homes listed for rent may also say in remarks that they would consider renting with an option to buy. Some owners might consider this if they are renting in hopes of selling when the market is better (in which case they might agree to sell at a certain point based on an average of appraisals). Other owners might be holding onto the properties as long term investments, but you never know unless you ask what their intentions with the home are.
An alternative to "rent with option to buy" is for renter and home owner to sign an agreement that the renter has the "first right of refusal" if the owner decides to sell the home. The owner may ask a renter to pay a little higher rent for this option, since a renter is getting an opportunity to match or make a better offer on a home than a potential home buyer who makes an offer of purchase to the home owner. The good news for a renter is that while he/she is paying a higher rent, there is less money to lose than in the rent "with option to buy" scenario if he/she decides not to purchase the home.
A final note on people buying homes from their landlords. At any point during the rent period,and I mean literally any point (i.e. 1 day, 1 week, 1 month, 5 months, toward the end of the lease, any other time during the lease) either a landlord can tell the renter that he/she would like to sell the home to the renter and could they agree to a terms OR the renter could tell the landlord that he/she wants to buy the home and could they agree to terms. If you go this route,then the buyer is less financially vested in the home and doesn't (a)pay a premium rent or (b)a big up front fee for the exclusive right or first right of refusal to buy the home should the landlord decide to sell when the person is renting his/her home.
I hope this blog is helpful and has shed some light on the "rent with option to buy" topic and if it is for you as a home owner or potential renter.
If you are thinking of renting and want to talk more about rent with option to buy, or rent with first right of refusal, I would be happy to talk with you. Just call or send me an email and I will be delighted to connect you.
Meanwhile, if you or someone you know is thinking of selling or buying, I greatly appreciate and always have time for your referrals.
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