With rent-to-own homes, you get to try the home on for size while holding the door open to purchasing the home later. As you’re paying your regular monthly rent, you can also set aside extra funds that will go toward your eventual down payment. That gives you more time to work on your credit score and get ready for a mortgage.
But buying a million-dollar house comes with a jumbo mortgage, and you could be in big financial trouble if you bite off more than you can chew. Defaulting on your mortgage can tank your credit score, plus you could lose your house.
Why not test the waters and make sure you can afford the home by renting first? Although it’s not common, you can rent-to-own million-dollar homes. It’s a way to get yourself into a really nice home today — not, you know, five years from now. We’ve talked to a luxury home expert and run the numbers to show you just how people make rent-to-own work with costlier homes.
When does it make sense to rent-to-own a million-dollar home?
Rent-to-own homes are not for everyone. This method of buying a home can be more complicated than a straightforward home purchase, and it’s not a widely used technique.
However, for certain buyers, renting a home before buying it is a method that can solve problems. Whether you’re struggling with a hot housing market or concerns about your credit score, rent-to-own homes could be your ticket to homeownership.
When starter homes cost a million dollars where you live
Red-hot market prices make it tough to get into your first home when the price of entry is a million bucks. If you live in a high cost-of-living area, you’re familiar with home prices in the millions. Even small homes can easily go for $1 million in markets such as Austin, Seattle, and San Francisco, where the median list price of a home is $1.6 million.
And in the era of the coronavirus, “Many landlords have been lowering rents to get tenants in large cities,” says Aviva Pinto, CDFA, CDS, managing director at Wealthspire. When rents and home prices are volatile, it could make sense to lock in a home price — and a rent — that works with your budget.
Big list prices mean big down payments, too, and it can take a while to save up that sort of cash. For example, if you want to put 20% down on a million-dollar house, you’ll need to bank $200,000 first — plus $40,000 to cover closing costs, which are typically about 4% of the price of the home. Depending on your salary and other expenses, that could take a long time to save up.
But by using rent-to-own for these million-dollar properties, you open up a new path to homeownership, giving yourself more time to save up a down payment.
When you don’t have a credit history in the U.S.
Your credit history is very, very important to mortgage lenders. They don’t hand out home loans to just anyone; they need to be sure that you’re going to pay back what you borrow, and that’s especially true when you’re talking million-dollar mortgages, known in the industry as jumbo home loans.
If you don’t have a strong credit history in the U.S., whether because you’re coming from another country or you simply haven’t built a history here yet, that can make it tough to get a home loan.
While lenders may be able to use manual underwriting to vet you for a loan, you’ll still need, at the very least, 10% for a down payment ($100,000 on a million-dollar home) and 12 months of mortgage payments in reserve ($30,000 to $40,000 cash).
But with a rent-to-own home, you can use the “renting” period to also build up your credit score, proving to mortgage lenders that you’re a safe bet for that eventual home loan. Plus, the better your score, the more likely you are to win a lower interest rate on your mortgage when it’s time.
When you’ve found your dream house, and those are the terms
Of course, you might have a credit score that’s just fine, but the house you’ve fallen in love with comes with rent-to-own strings attached.
If so, consider the offer. Many sellers have found that structuring their home sale as a rent-to-own can be a win-win situation for all parties involved. It gives sellers guaranteed income, in the form of your rent. And if you intend to purchase the home, you’re more likely than other renters to take very good care of the property — an ideal tenant to a homeowner.
Rent-to-own brings a lot of perks and flexibility to the potential buyer, too. If you lock in a great price when you sign the rent-to-own agreement, and the home appreciates in value, you could walk into your new mortgage with instant equity when it comes time to purchase.
If the million-dollar home you’re considering is a rent-to-own, it’s a good idea to examine the potential and see if the overall deal could work out in your favor.
When you want to take a home for a test-drive
Finally, the ability to rent-to-own million-dollar homes opens the door for testing out not only the home, but also the schools, the community, and even your commute.
Sometimes, it’s hard to know whether someplace can really feel like home until you’ve lived there. Plus, you don’t want to get six months into a mortgage and find out the neighborhood isn’t meeting your needs, or the drive to work is way longer than you expected.
With rent-to-own, you’re not locked into a mortgage and forced to try to sell if you decide the home and its location are not a good fit. Selling in the first couple years of a home loan might mean you lose money, since you’ve only been paying on the interest, and you have closing costs and other fees to factor in.
Rent-to-own lets you take the home for a test-drive, giving you added confidence that you are making the right decision when you do decide to buy.
How does it work?
If a rent-to-own million-dollar house sounds like a good solution for you, you’ll need to know how it works. Fortunately, the rent-to-own process is basically the same regardless of the home price.
Note that rent-to-own agreements may go by other names where you live, such as “lease option” or “lease with the option to purchase.”
Work with an agent
First of all, it’s a good idea to work with an agent for these deals. They’ve got the experience, not to mention the industry connections, to help you land just the right agreement.
Most importantly, your agent has your back. They have a fiduciary responsibility to look out for your best interest, and they have the know-how to help you avoid signing a contract that doesn’t benefit you at all.
Agents also have unique access to the MLS (multiple listing service) as well as their own network, which can help you to find these rent-to-own million-dollar homes. And if you don’t live in an expensive area, an agent might actually be the only route to finding these types of homes.
Rick Fuller, a Contra Costa County, California, agent who works with 75% more single-family homes than the average agent there, says an agent is indispensable in rent-to-own or lease-option situations.
“Knowing the market value and where the market is going may be very helpful in establishing a lease option,” Fuller says.
Your agent can help you identify a rent-to-own situation in an up-and-coming neighborhood, where home prices are poised to explode. But they can also help you steer clear of declining areas, where you might be locked into an overly high price in a couple of years, compared to market value.
“You want to make sure that you don’t get into a lease option on a property and pre-define the price, and then find out two years, three years, or five years later that the property is worth less than what your option agreement is,” Fuller says.
If home prices are a million dollars now, but $800,000 down the road, you’ve lost out on your option money. You’ve also locked in a bad price and wasted time on a house in a neighborhood you might not want to be in later.
Put down a deposit
Once you and your agent have landed on the right home, you’ll likely need to put down a deposit to lock it in. If you decide to buy the house later, this will be rolled into your down payment.
You’ll probably also be required to pay what’s known as a rent premium, or option money. This is an additional amount of money included in your rent payment that is set aside, to be used toward your eventual down payment. If you don’t decide to buy, in some agreements, the seller pockets this cash instead.
Read the fine print
Typically, you’ll agree on the purchase price in advance, when you sign the contract.
“The best way to draft a lease option for the tenant is to define a price, the owner agrees to that price,” and then both tenant and owner should factor in market appreciation as they settle on the price, Fuller says. When you’re ready to exercise the option to buy, you’ve already got money set aside for the down payment or closing costs, and if the property appreciates in value beyond what you offered to pay for it, you automatically have equity in the property.
“If the property has appreciated like what we’ve seen in recent years in the San Francisco Bay area and Sacramento County, then you automatically have equity at the time you close escrow,” says Fuller.
That’s because you already agreed upon a price at the time of signing the lease, “which may have been two, three, four, even five years prior,” he says. Homes in hot markets can appreciate a lot in that amount of time.
Don’t feel bad for the landlord, either; they’ve been renting to a tenant who has a vested interest in caring for the property. In fact, find out before you sign whether you’ll be responsible for maintenance costs while you’re renting there.
It’s quite common for the renters in rent-to-own situations to take on most of the maintenance, unlike in typical rental agreements. Since you may become the eventual owner, anyway, it’s to your benefit to make sure repairs and maintenance are done well and on time.
Go over your contract with a fine-toothed comb so you know exactly what’s expected of you and just what will happen if things do (or don’t) go your way when it comes time to purchase.
Terms for rent-to-owns are usually two years, and you’ll generally have one of two options: lease option agreement, or lease-purchase agreement.
A lease option agreement gives you the option to buy the house, while a lease purchase agreement requires you to purchase it. Lease purchase agreements are almost never a good deal for buyers. Make sure you know which agreement you’re signing because you could be locking yourself into buying the home down the line, even if your circumstances change.
Always worth a look
As you weigh the pros and cons of a rent-to-own, million-dollar home, remember that there is no one true path to homeownership. The important thing to do is to take the long view and make informed decisions.
That’s where your agent is really going to come in clutch: helping you understand the market you’re looking to buy in, the deal that you’re considering, and the longer-term ramifications of your potential investment.
With the right agent behind you, you may find an unconventional way to get into the home of your dreams, at a price you can actually afford.
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