Mortgage Rates Are Rising. Here's How That Could Affect a Rent-to-Own Purchase

It could trip up a lot of buyers.

Some people go from renting a home to buying one. But others might take more of an interim step by going the rent-to-own route.

With a rent-to-own arrangement, you sign a contract that has you renting a home from its owner for a certain number of years with a portion of your rent payments going toward the future purchase of that home. It's a viable arrangement if you can't qualify for a mortgage just yet (say, you need to build up your credit or save up a down payment) but you don't want to keep on renting indefinitely. 

Now, let's get one thing out of the way. Rent-to-own setups are a mixed bag. Yes, you pay money in rent that gets partially allocated to a home purchase. But you might also end up paying a lot more for a rental under a rent-to-own arrangement. And, you're not guaranteed to get a mortgage after all is said and done. So you could end up paying all of that extra rent for nothing.

Plus, with a rent-to-own contract, you agree to a preset sale price. But the market could shift from the time you sign your contract to the time you're ready to buy. And that could work to your benefit, but also, work against you.

In fact, given the way mortgage rates have been rising, signing a rent-to-own contract could be a risky prospect right now. Here's why.

It's all about affordability

It's important to not get in over your head when buying a home. Chances are, housing is and will remain your largest monthly expense. But if you spend too much on it, you'll risk a scenario where you start to fall behind on other bills. 

In fact, as a general rule, you don't want to spend more than 30% of your take-home pay on housing. And by "housing," we're talking about not only a mortgage payment, but also, added home-related expenses you know you'll face, like property taxes and homeowners insurance premiums.

How do rising mortgage rates play into that? It's simple. 

When you enter into a rent-to-own agreement, you commit to a specific home purchase price. And you may be okay with that purchase price based on mortgage rates being at a certain level. But if rates climb a lot, you could end up getting stuck with a much higher monthly mortgage payment than you may have bargained for. 

What’s more, depending on how much of an increase you're looking at, a lender may determine you don't earn enough to cover the higher mortgage payments in question. So even if you're willing to stretch your budget to move forward with your rent-to-own purchase, that may not be an option. 

Be careful when renting to own

It's easy to see why a rent-to-own arrangement might be appealing. But before you commit to one, consider the drawbacks involved. And also, think about the way rising mortgage rates could impact your home purchase -- and finances on a whole.