In 2022, the home buying process is getting harder and harder than ever before. Millennials are having an exceptionally difficult time buying a house as prices skyrocket to new all-time highs.
This is pushing many aspiring homeowners into alternative strategies for purchasing a home. After all, paying down a mortgage and building equity will always be better than paying rent.
So what are these alternative strategies? One is rent to own. You start out renting a home, making payments, and working towards the ability to purchase it.
Rent-to-own vs. mortgage, which option is better for you to pursue in this market? Keep reading our rent-to-own guide down below to find out now.
What Is a Mortgage?
Way back in the day, people purchased land (or got it for free) and built a house with their own two hands, and with the help of their community.
Fast forward a few years, and purchasing a newly built home was cheap enough for many Americans to do with cash.
But as the years went on, the price of a house just kept rising. Eventually, most Americans lacked the cash to buy a house and needed a loan.
The typical loan for a home purchase is a mortgage. It’s how most homebuyers acquire their homes today.
So how does a mortgage work? Lenders will evaluate your borrowing potential. If you qualify, according to their strict standards, they will give you the money you need to purchase a house.
The loan typically has a 30-year payback period with equal monthly payments. In the beginning, most of your payment is interest, and very little of it actually pays back the principal on the loan.
Over the years, this ratio shifts until you have paid most of your interest and are now paying down your principal.
The biggest benefit of a mortgage is that the title of the home is in your name from the very beginning. The bank or lender doesn’t want the house, they just want to make money each month.
So you have complete ownership of the house. But they have a lien against it. So if you fail to pay back your loan, the lender can take back the house, sell it, and reclaim their money.
How to Get a Mortgage
To get a conventional mortgage, you’ll need to have a steady income. For best results, this should be a W-2 job that you’ve spent at least the past two years at.
You also want to minimize other forms of debt. Mortgage lenders want to ensure that you have a debt-to-income ratio (DTI) under 40%. That is, with your potential mortgage, no more than 40% of your income will go towards debt payments each month.
Lenders want to see the highest possible credit score, which shows that you are a trustworthy borrower who is likely to make good on your payments.
And lastly, you’ll need to provide a down payment. Lenders won’t provide you with a loan for 100% of the purchase price. They expect you to put some skin in the game.
Conventional loans require 20% down. But many lenders will only require 5% or 10% down. Certain programs, like FHA, may allow as little as 3.5% down.
What Is Rent-To-Own?
So what if a conventional mortgage is off the table, due to lack of down payment, inconsistent employment history, or other reasons? The rent-to-own program is another option.
This is a type of contract that states you will rent a property and eventually plan to purchase the property. This type of agreement comes with a few benefits.
For those who lack the funds required for the down payment, this option helps you get into a house just by paying monthly rent. And second, if you are afraid to commit to purchasing a house, rent-to-own can help you move towards buying a house while still having the option to back out if necessary.
How Rent-To-Own Works
The goal of a rent-to-own contract is to use your monthly rent payments to build up enough equity to purchase the house.
With each monthly rent payment, some or all of your payment is sent to an equity account. Over the years, this builds up until you have enough to make a down payment on the home.
So rather than throwing your money away on typical rent payments, each monthly payment is helping you build an ownership stake in the property.
There are two types of contracts you can sign. A lease option gives you the option to purchase the house but also gives you the option to back out later on.
If you back out, the money you put towards the house will be gone, just like traditional rent.
With a lease purchase, however, you’re locked into the purchase of the property. You can’t back out without facing penalties.
So if you can’t afford to buy a house right now, and need to get your financial ducks in a row, the rent-to-own option helps you move towards a house purchase while working on your finances, all at the same time.
Plus, you’re already in the house you plan to buy, so there won’t be any moving to do later on.
Rent-To-Own vs. Mortgage
So which option is right for you? It all comes down to your finances. If you can qualify for a mortgage and have the funds needed for a down payment, then buying the house right now is the better option.
That way, you can start building equity and take advantage of price appreciation over the years.
But if you can’t qualify for a mortgage right now, or don’t have money for a down payment, rent to own allows you to start building an ownership stake in a property so that in a few years, you’ll own a home.
And even if you don’t want to stay in that house forever, you can decide if you want to rent or sell it and buy something else. Have a look here to learn about the options available to you.
Yes, You Can Buy a House
Now that you know the key differences between rent-to-own vs. mortgage, you can figure out which path to pursue.
The best thing you can do is own a house, so whatever it takes, make it happen. In 10 years, 20 years, and beyond, you’ll be very grateful you did.
To read more on topics like this, check out the Finance category