Rent-to-own options in housing: Move in now, buy later

Soaring home prices. Tight inventories. Student debt. Job mobility. Inability to save enough. Bad credit scores.

There is a slate of reasons why homeownership lies beyond the reach of many people.

For JB Harmon, a sales engineer manager in suburban Atlanta, it was a less-than-ideal credit score.

Purchasing a home seemed improbable until Harmon learned about Divvy Homes' lease-option program.

A lease option, which also may be referred to as a lease purchase, rent-to-own, lease-with-the-right-to-buy or contract-for-deed agreement, offers a tenant the possibility of purchasing the rental home they live in. The nontraditional approach to homeownership is being overhauled from a sordid past.

Rent-to-own contracts for residences began to mushroom in the mid-20th century, when lenders would not work with African Americans. In such compacts, a tenant would pay a premium (an amount in addition to rent) for the option to purchase the property at a later date. Over the years, many investors and landlords offering lease options have faced criticism and lawsuits accusing them of ensnaring minorities and low-income people in unfair deals.

"That option premium, it was just a fee," said Adena Hefets, founder of Divvy Homes. "You didn't own any equity from it. It was purely a fee. And if you missed any single payment, you would lose your rights to buy the home. So that's why it came across as extremely predatory."

Lease-option companies these days say they operate under more customer-friendly business practices. Divvy, which currently operates in eight markets nationwide, is among a cadre of relatively young companies and start-ups re-imagining contracts for deed by offering aspiring homeowners more say and more financial leverage.

The start-ups cater to a wide variety of customers, from young professionals who often relocate for work to families who struggle to amass enough for a down payment to those who need to improve their credit scores.

Although statistics quantifying the level of activity in the movement are hard to come by, the Terner Center for Housing Innovation at University of California, Berkeley in a 2017 report said: "Particularly in the wake of the financial crisis, the benefits of this type of alternative model have led to a resurgence of interest in lease-purchase, and both public and private-sector actors have been exploring the viability of lease-purchase products to responsibly and sustainably help families enter homeownership."

The rent-to-own companies usually purchase the single-family houses their customers want but cannot or will not buy outright for a variety of reasons. The clients become renters (and sometimes partial owners) who, under predefined terms, have the choice to buy the property during the option period.

Given the history of lease options, and the complexity, it's important to do your homework.

Here's what you need to consider if you're exploring a lease option as a path toward homeownership:

Work with an agent

Finding a reputable real estate agent should be the first step in finding a legitimate rent-to-own company.

While they may operate within the same realm, rent-to-own companies and investors differ in how they prequalify customers, structure payments and negotiate purchases. An agent can help walk you through the process.

Most of those ventures team up with brokerages to educate agents on their modus operandi. For instance, Home Partners of America (HPA), whose lease-option program is available in 41 markets, has a partnership with Century 21.

That is how Beverly Drewery, an agent with Century 21 New Millennium in Maryland, first heard of HPA. In 2015, after taking self-guided courses on the specifics of HPA's rent-to-own package, she become an HPA certified agent.

In the four years since, Drewery said she has witnessed a steady rise in clients who seek HPA as a means toward buying a home.

"We've seen people who just don't have the resources for the down payment, so we are seeing an increase in the number of [people interested] in [HPA's] program," said Drewery, adding that in the past year she has helped a dozen clients purchase a home with HPA.

It is also beneficial to meet with a couple of lenders to gauge buying power and outline any steps needed to repair credit scores and boost budgets while a lease-option lasts.

"I think people should talk with a mortgage broker so they know what they need to work on if mortgage readiness is part of their challenge," said Marjorie Scholtz, founder and chief executive of San Francisco-based Verbhouse.

Harmon's real estate agent introduced him to the program.

In early 2019, Divvy purchased a three-bedroom, two-bathroom ranch house for $127,900 for Harmon. He spent the next three months working with a credit repair specialist and paying out of pocket for fixes to the garage in order to qualify for a home loan from the Federal Housing Administration.

"Divvy allowed me to get the exact home I wanted at the correct time," he said via email.

Otherwise, Harmon said he would have had to shell out more than $1,000 a month in rent for a smaller house and as much for storage. By leasing from Divvy (with monthly payments going toward both rent and equity in the home), he was able to cut his housing expenses in half, he said.

Three months after entering the rent-to-own agreement, Harmon said he bought the house outright for $134,000.

Structure of the programs

The monetary mechanics of the lease-option companies vary. Divvy, for instance, requires that clients contribute some 2% of the home's value when the company buys it for them.

"That's what we call their initial savings," Hefets said.

With Divvy, each monthly payment resembles a mortgage outlay in that a portion of the amount goes toward raising equity for residents and the rest covers the interest or rent profit for Divvy.

"[Customers] build up their ownership so that 2% goes up to 2.2% the first month, to 2.4% the next month," said Hefets. "We build them up to total of 10% over the course of three years."

Verbhouse, which is rolling out a pilot program for educators, has a similar structure. A tenant buyer initially pays 5% of the home's value, while each monthly installment splits toward both rent and equity.

"If the down payment is a challenge for [clients] and they haven't built equity, then they're going to have the same challenge at the end of the [lease] term as they did in the beginning," said Scholtz.

While Verbhouse's 5% upfront requirement may suffice for a mortgage down payment, it pivots to customers whose financial history might preclude them from securing a home loan or borrowing a large enough sum. It could also appeal to those who, prior to buying, prefer to assay living in a neighborhood, which offers few other rental possibilities.

Where rent-to-own companies seem to converge is the overall process of executing an agreement.

They buy houses that are listed for sale, not rental properties.

"Sometimes homes that are listed for sale are of a [better] quality than rental homes or an apartment," said Tracey Jeter, vice president of marketing with HPA.

Many lease-option companies operate in the low-to-median range of home prices in any given market. Divvy, for example, purchases houses, listed from $60,000 to $350,000, depending on the city, said Hefets. The average price Divvy pays is "$165,000 for a three-bedroom, two-bathroom, certainly 1,800-square feet home," she said.

On its website, HPA states it considers houses with an asking price between $100,000 and $450,000.

But rent-to-own companies work with their clients to establish the maximum price they would pay for a home. Then, the company presents a cash offer to the seller, which carries an appeal in many real estate markets. Some firms also pay for inspections, closing costs and repairs.

Yet before they do all that, lease-option companies evaluate houses (assessing details such as proximity to commercial hubs and location in a flood zone) and vet clients. The latter is more akin to a lease prequalification check than a stringent mortgage screening. However, unlike tenants and similar to homeowners, rent-to-own customers often share some of the burden of maintenance, especially regular upkeep. Some companies, though, take on major expenses.

"Divvy did replace a water heater for me when they still owned the home," said Harmon. "They gave me the contact information for a local plumber, I booked the appointment, and they covered the cost."

Buying a home comes with piles of documents. So do lease options. Depending on the rent-to-own company, there might be an accord to make an offer on a house, a document on joint expectations, a lease contract, an option-to-purchase agreement, a separate covenant on exit clauses.

"There are documents for each phase," of the rent-to-own process, said Andrew Schultz, partner at the law firm Manatt, Phelps & Phillips, which helped Verbhouse craft its legal framework. "This whole process has to be set out so that people know what to expect and what their financial obligations will be."

Aside from a purchase price and monthly payments, the documents should also state the price at which a tenant-buyer can purchase the home outright, or exercise their lease option, at any time.

With HPA, for instance, the agreed-on buyback price grows every year at a predetermined rate to factor appreciation expectations. Meanwhile, Divvy and Verbhouse lock in the price at which a tenant can acquire the house.

Customers get the deed only when they purchase the home. In the time they spend as tenants (and in some cases, partial owners), the title of ownership belongs to the rent-to-own company.

How to get out of it

In 2017, Stephen and Mercy Hilliard were preparing to get married. They sought a single-family rental in White Plains, Maryland, to accommodate their blended family of six children, three of whom still lived with them.

The couple, facing wedding costs and career changes, were reluctant to make the huge commitment, financial and otherwise, to homeownership. But HPA's lease option spurred them to change their minds.

"With the option to buy the home that you're renting, it was a good opportunity to just kind of get your foot in the door," Stephen Hilliard said. "It was a great program for not necessarily second-chance credit but it gave you the opportunity to get into a home without having all the same requirements of actually buying."

Stephen Hilliard said rent-to-own emerged as a viable solution after touring properties and talking with Drewery, his agent, about the family's background, current situation and goals.

The Hilliards paid about $2,000 a month in rent when they moved into the townhouse HPA bought on their behalf in 2017 for nearly $270,000. They had to put a deposit of first and last month's rent, which HPA usually counts toward a down payment when tenants decide to purchase.

While the Hilliards' rent expenses did not grow equity in the townhouse, they had five years to buy out HPA for their home. Every year, however, the home price would inch up by a percentage the family and HPA had agreed on.

The home price "went up about maybe $9,000 every year," said Stephen Hilliard, who in late 2019 walked away from the lease option with HPA to acquire a larger single-family house.

"We really want to make sure that we're being fair to the residents," said Jeter, vice president of marketing with HPA. "If they decided it is not the home for them, there's no penalty to them, there's no obligation for them to purchase."

At the start of the new year, the Hilliards were still moving into their new residence. Severing the rent-to-own contract with HPA presented no major challenges, said Stephen Hilliard. Yet, there were some specifics the family had not realized earlier - like the fact that the lease automatically renews at the end of each one-year term. Unlike conventional leases, it does not roll into a month-to-month rental that bears flexible end dates when the initial contract expires.

"We had already started our process of buying a new home when we found out [about this] but it wasn't anything on [HPA's] part," said Stephen Hilliard, adding that he reread HPA's lease documents, which outlined the policy.

The Hilliards had to submit a 60-day notice of their intent to abandon the lease. Awaiting a move-out inspection of the HPA home, they nonetheless expect to pay no penalties and to receive their security deposit back.

In the overall rent-to-own segment, purchasing a house at a predefined price, often set some years earlier, not only leaves little room for negotiations; it may be unwise when home values depreciate.

In such circumstances, HPA customers may shun a purchase, taking no losses because they do not own equity in the homes they rent. Divvy and Verbhouse clients, though, may see their homeownership stake diminish in value and face the decision to overpay for the residence or cash out of the lease option.

"In some respects, the tenant is taking some of the risks of homeownership," said Schultz. "They have some of the risks and some of the benefits."