Rent-to-own: A debatable path to homeownership

Not quite an owner, but more than a renter: A lease-to-own agreement is a bit like housing purgatory.

But the arrangement is increasingly popular today because more sellers are having trouble unloading their homes in the real estate recession and plenty of buyers can't get a mortgage because skittish lenders are cutting back on making loans.

Through a rent-to-own contract, a renter locks in the right to buy a home at a later date at a set price. The renter puts down a nonrefundable deposit, and sometimes — depending on the contract — part of the monthly rent goes toward the down payment.

There are pros and cons on both sides. These agreements can help a seller get through a slow market with a little cash in the pocket, but a bad tenant can spoil the deal. Renters can potentially build home equity now even though they're not ready to buy. But it might be better to wait until you're financially settled before jumping into a large commitment.

The Web site ForSaleByOwner.com is receiving more requests for rent-to-own listings from both buyers and sellers, and it's working overtime to make searching for that option on their site easier, says Greg Healy, vice president of the company's operations.

And anecdotal evidence from real estate agents around the country suggests that these types of deals are on the rise, especially in the old boomtown markets where housing prices are still unaffordable despite recent sharp declines.

"We're seeing more of these than in a normal market," says Steve Goddard, a broker manager for Re/Max Marquee Partners in Manhattan Beach, Calif.

The arrangement is complicated with many moving parts. Think of it as combining a purchase and rental agreement. Both parties should go into it with help from a real estate attorney or at least a real estate agent well-versed on rent-to-own arrangements.

"You need to have a strong contract to make it work, not just a good handshake," Goddard says.

To start, the renter and seller agree on a fair price for the home. This can be tricky. A renter could lose out if the home declines in value before he or she can buy it. Or, the seller could get the short end if home prices appreciate more than expected.

Once a price is set, the renter pays a deposit, or option payment, to the seller, guaranteeing his or her right to buy the home in a set time. For example, a seller may ask for $10,000, or 2 percent, on a $500,000 home.

The two parties must also agree on a monthly payment and determine if any of it goes toward the down payment. Often times, rent-to-owners are willing to pay up to 10 percent above market rents to secure the home, especially if part of the money goes toward adding to the down payment, Goddard says.

In addition to the purchase price and rent, there are many other important conditions that should be outlined in the agreement. Consider the gamut of scenarios for the sale and the rental arrangement and try to head off conflict before running into one of them.

For example, can the terms be extended if the renter can't buy at the set time? If so, for how long, and should the renter be required to increase his or her deposit? What happens if the renter falls behind on the monthly payments? Who pays for the maintenance and repairs of the house?

The eventual buyer should be ready for a vetting process that mirrors most rental applications. Prudent sellers will run credit checks and ask for income and employment verification to make sure the renter can afford the monthly payments.

The worst-case scenario for a seller is getting a tenant who can't pay rent, trashes the place and doesn't buy it.

Similarly, renters should treat the agreement like they're buying a house. Get an appraisal and a home inspection. Check into the seller's mortgage status too. He should be making his monthly bills on time.

"You're taking the normal steps of purchasing a home. You're not skipping out on the work," Healy says.

However, if you're not financially ready to buy a home, don't rent-to-own, says Chris Krehmeyer, a housing counselor with Beyond Housing in St. Louis. Skip the shortcuts. Wait a few years. Create a financial game plan. Clean up your credit. Save a little cash each month for a down payment.

He worries that people will jump into agreements without fully understanding the financial considerations, similar to buyers during the housing boom who signed up for exotic loans they didn't understand and ultimately couldn't afford.

He also suggests contacting a nonprofit credit or housing counseling service to help with the planning.

"We can set you on the path to the American Dream," he says.

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