Rent-to-own homes: What are they and how do they work?

Rent-to-own homes can be a great alternative if you can't afford to buy a home outright, have a low credit score or don't have enough money for a down payment. Rent-to-own homes can also give you the chance to see how you like a home and neighborhood without committing to buying it.

However, there are a few things to consider before entering into a rent-to-own agreement, including understanding which type of rent-to-own agreement best suits your needs and the potential drawbacks. This is an educational article to provide market insight.

What is rent-to-own?

Simply put, rent-to-own is when you rent a home for a certain period of time before you buy it. The structure of the agreement will determine whether or not you can walk away from the home without purchasing it after the rental period. Depending on the terms of the rent-to-own agreement, that period can range from several months to several years. These contracts are different from a traditional renter's lease or purchase contract. The main goal of rent-to-own is to provide potential buyers time to improve their financial situation while living in their future home.

How does rent-to-own work?

As part of your rent-to-own agreement, the seller agrees to put a certain amount of money from your monthly rent payments toward equity in the home. This arrangement allows you to build equity while renting—and eventually, use the accumulated funds as part of your down payment when you purchase the home.

Types of rent-to-own agreements

There are two kinds of rent-to-own agreements: lease purchase and lease option.

• Lease option: You have the option to purchase the home after a specific time period you and the property owner have agreed on. This type of contract is beneficial if you want the flexibility to decide whether to buy the property after renting.
• Lease purchase: A lease purchase contract is more binding than a lease option. With this type of contract, you're legally obligated to buy the home at the end of the lease term, regardless of your financial situation or changes in market conditions. Failing to move forward with purchasing the property could also result in legal action and a loss of any financial investments you’ve made during the lease.

Rent-to-own agreement basics

There's no one-size-fits-all approach when it comes to rent-to-own homes. However, these types of transactions typically have several standard components, including:

• Purchase price: A rent-to-own agreement typically specifies the home's purchase price. In some cases, the price won't be determined until the lease expires, which could benefit sellers if property values increase.
• Rent payments: The rent-to-own agreement will specify the amount of rent you’ll pay each month. Rent prices for this type of home are usually higher than regular rental fees, since the owner sets aside a portion of your monthly payment for you to use toward your future purchase of the property.
• Maintenance: The contract will note who is responsible for covering maintenance—you or the property owner. This is one of the trickier parts of a rent-to-own home. Make sure you understand what you're agreeing to repair if maintenance is necessary.
• Option fee: As part of a rent-to-own agreement, you may be required to pay a one-time, non-refundable fee—also known as an option fee—which gives you the exclusive right to purchase the property at a later date.
• Lease term: The contract will specify the terms of the lease and how long you'll be renting before moving forward with a purchase. Lease terms usually last less than three years, but this can vary depending on the situation.rent-to-own-home-leases

The pros and cons of rent-to-own

Rent-to-own home listings aren’t as common as sale or rental listings. Usually, they happen under specific circumstances, such as:

• The property owner is having trouble selling the home.
• The renter already lives there and is happy with the property, but the landlord wants to sell.
• The home has been on the market for some time, and a prospective buyer approaches the seller with a rent-to-own offer.

Rent-to-own homes aren't for everyone, so it’s important to be aware of the advantages and disadvantages before entering into a rent-to-own agreement:

Pros

The advantages of a rent-to-own agreement may include:

• Building equity while renting: Rather than having to save up the cash for a down payment, you may be able to build equity in the home by paying higher rent over one or multiple years.
• Avoiding competition: By signing a rent-to-own agreement, you know you'll have the option to purchase the home at the end of the lease, meaning you won’t have to compete with other buyers.
• Waiting to qualify for a mortgage: If you need to improve your credit score or pay off debt before you can save up for a down payment, a rent-to-own agreement can be a great option. It helps you secure the home you want while giving you more time before you need to look for financing.

Cons

The disadvantages of a rent-to-own agreement may include:

• Non-refundable option fee: To have the option to buy the home at the end of your lease, you may need to pay a percentage of the home's purchase price upfront. If you decide not to purchase, you likely won't get this money back.
• Maintenance costs: You might find yourself responsible for repairs for a home you don't yet own. In the event of an emergency, you could be out hundreds, even thousands, of dollars.
• Home value fluctuations: If you have a rent-to-own agreement where your lease is set for an extended period of time, there's no way to know what the housing market will do during that time. If the purchase price reflected inflated prices when the contract was created, you could end up paying more for your home than it's worth when it's time to buy.
• Hard-to-change terms: Situations change. Your job might require you to relocate to a new area, or you may find that you can’t qualify for the mortgage you need to buy the house. As long as you have a lease option, you can walk away. However, if you were paying higher rent with the idea that it would convert to equity in the home after purchase, you’ll lose out on that money.
• Legal repercussions: If you’re locked into a lease purchase agreement and fail to buy the property, you may face legal consequences, on top of the loss of any financial investments you’ve made toward the property during the lease.

In some cases, you might be better off renting than buying through a lease-to-own contract. As a renter, you can spend time saving money or working to build your credit before purchasing a home. To help you decide which path is right for you, thoroughly consider the pros and cons. If the advantages far outweigh the disadvantages, this might be a good option for you.

How to get a rent-to-own house

Once a seller has agreed to a rent-to-own agreement the steps you’ll take include:

1. Find a rent-to-own opportunity

As you’ve probably already guessed, the first step in the process is to find a rent-to-own opportunity and begin negotiations with the owner.

2. Agree to a purchase price

You can get a general idea of local market prices by looking at similar listings in the neighborhood or nearby areas. It’s crucial to ensure the price is fair and reflects the current market trends. Consider adding a contingency clause that the appraised value must be at least the amount of the agreed upon sales price.

3. Determine the rental term's length

Typically, rent-to-own agreements are for less than three years.rent-to-own-home-leasesrent-to-own-home-leases Consider where you are financially and how long it will take you to be ready to qualify for a mortgage. If your credit score isn't where it needs to be to qualify for a good interest rate, you might want to consider a longer rental period.

4. Define maintenance roles

Each rent-to-own contract is unique, so it's important to get in writing what you'll be responsible for as the renter. For example, are you responsible for only what's inside the home, such as appliances and other repairs? Or are you also responsible for lawn maintenance and the AC unit?

5. Negotiate rent payments

With a rent-to-own contract, the rent is usually higher than it would be in a normal renting situation. You might be able to negotiate the amount you pay, although it's important to get in writing exactly how much of your payment will go toward your property purchase.

6. Sign the contract

Once you’ve come to an agreement, both parties need to sign the contract. Since there are two kinds of rent-to-own agreements, it's important you understand what you're agreeing to. Watch out for lease-to-purchase agreements, as you may be legally obligated to buy the home at the end of your lease, whether you can afford it or not.

7. Shop for a mortgage lender

As the rental term for the property nears its end, you'll want to shop around for a mortgage lender to obtain financing, as you would with any other home purchase, for when the lease ends.

The money set aside from your rent payments may also be credited to you at this point. Lenders may have guidelines that limit how much can actually be credited, such as only permitting the amount you can document that was paid above market rent. Nonetheless, getting preapproved by a mortgage lender can help you understand what you can afford and what loan options are available to you.

8. Keep Records

Retain copies of checks, bank statements or other documentation to prove what you have actually paid. This documentation may be required by your lender to ensure the rent credits are applied correctly.

After you get your mortgage, you’ll also want to keep your loan documents for your financial records.

In summary

A rent-to-own home contract allows potential homebuyers to move into a home right away while they save for a down payment or improve their credit score. That said, there are a number of factors to consider before you agree to a rent-to-own agreement. You should approach this arrangement with a thorough understanding of what it means, the contract terms and a realistic assessment of your financial readiness.

To help ensure you’re preapproved for enough money to start looking for rent-to-own homes, we encourage you to apply for a mortgage early in the process and consult with a mortgage lender or a real estate attorney. This step will help you navigate the rent-to-own process more confidently and secure a home that meets your long-term needs.

FAQs about rent-to-own homes

Is a rent-to-own home a good option for first-time home buyers?

Rent-to-own homes can be a great option for first-time home buyers who may not have enough savings for a down payment or need time to improve their credit score. This option allows you to live in your future home while you work on meeting the necessary financial requirements.

However, it's important to carefully read and understand the terms, as rent-to-own agreements can vary widely and may include higher monthly payments, a non-refundable option fee or both.

What should I look for in a rent-to-own agreement?

When reviewing a rent-to-own agreement, pay close attention to several key factors. Ensure the purchase price and terms are clearly outlined, including how much of your rent payments will go toward the purchase price. Check for any non-refundable fees, such as an option fee, and understand your responsibilities for maintenance and repairs.

It's also crucial to know the timeline for when you need to exercise the option to purchase the property. Consulting with a real estate attorney can help you navigate these agreements and protect your interests.

How do I find rent-to-own homes?

You can find rent-to-own homes through real estate agents, online listings and specialized websites. Again, it’s important that you thoroughly research each listing and potentially speak with a real estate attorney to ensure you’re making an informed decision before signing any type of rent-to-own agreement.

Are there rent-to-own scams?

Yes. Rent-to-own scams are definitely out there. That’s why it’s so crucial for you to do your research before locking in to a rent-to-own agreement. As a general rule, if a deal seems too good to be true, it probably is.