6 Key Rent to Own Contract FAQs
April 5, 2016 by Marty Orefice | Contracts, Real Estate, Rent to Own
Before entering into a rent to own contract, there are a variety of details you should be careful with. By asking the right questions, you can minimize your chances of trouble or confusion during your lease. Here are some rent to own contract FAQs you should be asking:
1. Who pays for maintenance, property taxes, and homeowner’s insurance?
Ordinarily, your landlord/seller will pay for the property tax fees and homeowner’s insurance. This is because since he or she is still the legal homeowner and is ultimately responsible for the property. For a renter/tenant in a rent to own contract, this is an advantage for you. Without these liabilities, you will have more time to equip yourself financially.
On the other hand, renters are typically responsible for home maintenance fees and general housekeeping. In contrast to a traditional lease, a rent to own contract expects tenants to make their own repairs. This is because the tenant plans to own the home in a few years. In some cases, the landlord will pay for major repair costs if it exceeds a certain cost.
Essentially, it is crucial to understand who is responsible for paying the various types of costs. Your rent to own contract should clearly state how much time you have to fix a repair. It should also tell you what kinds of modifications you may make to the home. You and the landlord may negotiate the terms of the contract. However, don’t hesitate to consult a real estate attorney if you are unsure if the terms lie in your best interests.
2. What is my monthly base rent and rent premium going towards?
Many renters are thrown off when they discover that rent to own payments are higher than normal rent payments. Usually, the seller will charge a high enough monthly base rent that will go towards the cost of their mortgage payment, taxes, and insurance fees on the home. Your monthly base rent is equivalent to the fair market rent, which is different from your rent premium. Your rent premium is simply the extra amount you pay per month in addition to your base rent, which the seller will credit back to you if you decide to purchase the home at the end of the lease.
Less commonly, the seller does not collect enough base rent per month to completely cover the cost of their mortgage payments and homeowner fees. This tends to happen when houses are on the more pricey end of the market, so the landlord must pay relatively high-interest rates and high mortgage payments. In these cases, the landlord will have to pay the difference in the amount not covered by your monthly base rent.
Be aware that some landlords will attempt to evade the difference in the amount by charging higher than the market rate for monthly rent. Because of this, you should always check if your listed rent aligns with the fair market rent, which you can find out by contacting a mortgage lender or using the online tool Rentometer. If it does not, either negotiate a different price or go find a better deal!
3. Is the purchase price determined in the rent to own contract?
In most rent to own contracts, the purchase price is an estimate of the home’s fair market value at lease-end and is agreed upon in the contract. Similar to the rent price, you and the seller determine the purchase price before the lease begins. It remains the same, regardless of whether the fair market value fluctuates or not. The purchase price does not lean in favor of either the seller or the tenant since nobody knows for sure what the future fair market value will be.
At the end of the lease, if the actual fair market value exceeds the estimated fair market value, the buyer will benefit since they will be paying less for the house than they normally would. On the contrary, if the actual fair market value falls below the estimated fair market value, the seller will benefit since they will be receiving more for the home than they otherwise would.
You may check the current fair market value of a home by using a home value estimator. However, if you need help evaluating what the future fair market value of a home will be, you are better off consulting a local mortgage banker.
4. What fraction of the rent premium and option fee will the seller credit toward the home purchase?
For most rent to own contracts, the seller credits the total cost of your lease option fee and rent premium payments towards your down payment if you decide to exercise your option to purchase the home. A lease option fee, which you pay before the rent term begins, is a fee (usually 2-7% of the down payment cost) that guarantees you the option to buy the home in the future.
It is important to note that the lease option fee is NOT optional and every rent to own contract requires one. The lease option simply gives you the power, but not the obligation, to buy the home at any time during the rental period.
Generally, your option fee and rent premium payments are non-refundable; so if you decide to not purchase the home, you will probably not get this money back. In addition, many landlords are strict about timeliness. Some may even void your monthly rent credit if you do not make your rent payments on time. These conditions are characteristic of most rent to own contracts, but since every landlord is different, some may interpret the option fee or rent credit by their own terms. Because of this, you should always do your research, utilize your resources, and ask the landlord these important questions before entering into a transaction.
5. Under what conditions could the contract become void?
The landlord in a rent to own contract has the right to void the tenant’s contract if he or she violates lease responsibilities. Tenants can violate their lease in many ways. For example: keeping animals in the home if the lease is not pet-friendly, housing unwarranted people, participating in crime, and anything else specifically prohibited in the contract. Tenants may also be at risk of violating their lease if they make late rent payments or do not make the necessary repairs, depending on the contract.
Often times, the contract may become void if the tenant is unable to qualify for a mortgage at the end of the lease. Unfortunately, many unethical sellers will purposely make it difficult for the tenant to secure a mortgage at the end of the term. There are 5 Ways to Spot a Rent to Own Scam that you should be aware of. These tips will help you to investigate the seller’s history and past transactions to make sure they are credible.
In some cases, the tenant may void the contract his or herself if the seller does not have marketable title to the property. When this happens, the landlord must reimburse the tenant for the costs of the title search as well as any of their rent payments made so far and the option fee.
Know Your Contract
Despite the many risks associated with a rent to own contract becoming void, remember that this may only happen if the tenant fails to meet his or her obligations. Everything the landlord expects of you should be clearly stated in the contract; thus, it is imperative to review your contract’s terms before signing anything. If your contract has tricky wording, a real estate attorney can help clarify any questions you may have. As long as you consistently meet the expectations of your lease, your landlord will likely not have the means to void your contract.
6. Will the seller serve as a lender, or will you need a mortgage before the contract expires?
Normally, the seller will not serve as a mortgage lender. Seller lending is more common in contract for deed sales rather than lease options. Instead, the buyer will have to find their own financing for a mortgage. Time frames vary between sellers, but generally, you must get a mortgage no later than one month after the buyer has made their decision.
It is recommended that you seek advice from a mortgage broker prior to even entering a lease option. He or she will be able to gauge whether or not you will be able to qualify for a loan within the lease period. Although their predictions may not be 100% accurate, they can still provide you with valuable guidance.
Renting to own can be highly effective if done correctly. We can’t emphasize enough how important it is to ask these rent to own contract FAQs before signing the contract. Having read this article, you should now be well-equipped with relevant questions to ask about your lease option, as well as some potential answers, to be able to make a rational, well-informed decision.
