There are times when your bad credit score fails to convince mortgage lenders to lend you any money for investing in real estate. So, what do you do when you can’t get a mortgage? You find other real estate investment strategies that compliment your financial status, of course! In this article, we are going to help you with getting started in real estate through a rent to own strategy. As you’ll find out, this type of investment can be great for real estate investing for beginners.
Related: Top Six Real Estate Investment Strategies
So, without further ado, here is what you need to know about the rent to own real estate investment strategy:
#1. What Is Rent to Own Real Estate?
The concept of rent to own homes is simple. It is when you rent a house with the option to purchase the investment property at some agreed point in the future. For that option to be available to you, you pay what we call ‘the option fee.’ The rental period usually lasts from 2-5 years on average, though it could be less. By the end of that period, you will have the option either to buy the rental property or to let it go. So really, rent to own homes fall within the category of owner financing (seller financing), which is a form of creative real estate investing.
#2. How Does Rent to Own Work?
As a beginner real estate investor, you must first find a real estate agent. An agent has the right connections and knows where to find rent to own real estate. Once you come across a listing, you talk to the property owner and agree to the terms of the rent to own contract, you sign it, pay the ‘option money,’ and you are good to move into the rental property. Now, even though it seems like it’s all roses, there are pros and cons to this investment strategy, and that is next. But first, let’s talk about rent to own contracts.
Learn More: FAQs: How Does Rent to Own Work?
Rent to Own Contracts
Of course, you are going to sign an agreement with the property owner. But, there are a few things you must include in there so pay attention to the following:
1. Is it a ‘lease option’ or a ‘lease purchase’? There is a difference between the two. The first gives you the option of buying the investment property or letting it go by the end of the lease period. The latter, on the other hand, means that you are contractually obligated to purchase the property by the end of that period.
2. Include the purchase price. Many property buyers prefer to name the property price at the time of signing the contract while sellers prefer to do so at the end of the lease term. So, make sure you and the owner are on the same page when it comes to the property price.
3. What’s the rent price and where does it go? In a rent to own real estate deal, you pay higher rent. Typically, a portion of that rent goes towards the investment property price or the initial down payment you will have to pay in the future. Make sure you know whether a certain amount is going towards the property price in any form. Even if it doesn’t, you must at least know what’s going on and where the money is going so you can plan accordingly.
4. Who’s responsible for maintenance? In most cases, it is the buyer, so be prepared.
5. Set clear deadlines.
#3. Pros of Rent to Own Real Estate
1. The first advantage of rent to own real estate is obvious: the ability to buy an investment property with bad credit.
2. Most of the time, you will get the property for the current market value and not the future market value. Therefore, the appreciation difference is yours to keep as equity.
3. It gives you time to improve your credit score and prepare for owning a rental property.
4. It gives you a chance to test drive the investment property and walk away if you don’t like it.
#4. Cons of Rent to Own Real Estate
1. It takes a long time to acquire an investment property with this real estate strategy. But, in this case, you most probably have no other way.
2. You pay above market value rent unlike other types of rentals.
3. If you decide to walk away at the end of the rent period, you lose your initial payment as well as everything you have put into the investment property.
4. The possibility of losing the purchase option if you fall behind on rent is a risk of the strategy. Depending on the rent to own real estate contract, the owner has the right to evict you from the rental property if you fail to commit to your contractual obligations.
5. You do not acquire ownership in a rent to own real estate deal until the time comes to decide whether you want to buy it or not.
#5. A Few More Considerations
First of all, make sure you have enough knowledge of rent to own real estate. You can’t get into the business blindly without knowing the ups, downs, ins, and outs of it. It is a potential investment property for you, so have a plan in place so that you are sure about your decision to take this route.
Second, it is crucial that you work with a real estate attorney for setting the rent to own contract. Sometimes, the owner uses wording that obligates you to purchase the property at the end of the rent period. In this case, you won’t be able to back out of the purchase.
Third, talk to your bank before entering any agreements. Although you were refused a mortgage, it is a good idea to consult with your bank on the ways you can improve your credit score. You will have a period of 2-5 years to work on that. Also, bring up the topic of future investment property financing so that you know what your options are and how long it will take you to improve your credit score.
Related: How Can You Improve Your Credit Score for Financing Investment Properties?
Finally, do your due diligence which means that you must double check the profitability of the investment property. Perform an investment property analysis, a real estate market analysis, and a comparative market analysis. You also need predictive analytics to study the future of the real estate market in that specific location. For that, you can use Mashvisor’s investment property calculator. Learn more about our product.