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How Does Rent-to-Own Work?

Renting a house has several advantages and disadvantages. But, if you’re a renter and have your heart set on buying a house, a rent-to-own agreement is a path that can get you there. Understanding how it works is the first step in determining if it's the right move for you.

Rachel Velez • June 6, 2022

Purchasing a house can be a difficult goal if you have poor credit or don’t have the money for closing costs, inevitable home repairs, or a down payment. But, many people don’t want to rent forever since it doesn’t help you build equity and won’t put you in the right direction to becoming a homeowner.

As home prices continue to rise, those hoping to become a homeowner may want to explore less-traditional options in order to buy a house. With that in mind, choosing to rent-to-own (or lease-to-own) a home might be a good alternative to taking the more traditional route to homeownership. 

Both buyers and sellers can benefit from rent-to-own arrangements, but it’s essential that everyone understands the risks. Let’s go over what rent-to-own agreements are, how they work, and the pros and cons to help you decide if they’re a good option for you.

In This Article

  1. What Is “Rent-to-Own”?
  2. How to Rent-to-Own a Home
  3. Types of Rent-to-Own Contracts
  4. How to Find Rent-to-Own Homes
  5. Rent-to-Own Pros and Cons
  6. FAQs
  7. Final Thoughts: Is Rent-to-Own a Good Idea?

What Is “Rent-to-Own”?

Rent-to-own is a transaction or contract where a tenant and property owner enter into a lease with the understanding that the tenant wants to purchase the home after renting. The renter may pay an upfront fee, also known as an option fee, which is usually between 1% and 5% of the home’s purchase price

Although this fee is non-refundable, it can apply to some or all of the renter’s down payment when it’s time to purchase the home. This fee also gives the renter the right to purchase the home at a later date. This fee is in addition to the small payments the renter pays toward their eventual down payment, which is usually added to their regular monthly rent payments (making them a little higher than the market average). The tenant might also be responsible for maintenance of the home and repairs while they’re still renting, which would be listed in the contract if that’s the case.

How to Rent-to-Own a Home

State laws vary on rent-to-own contracts, but outside of jurisdictional requirements, the arrangement can be set up any way the tenant and property owner prefer and decide upon. Both parties must first agree on the purchase price, which can be difficult when the sale is usually happening several years in the future. Some contracts will state that an appraiser will determine the price of the house once it’s time for the tenant to purchase it. This sometimes makes it easier so the renter and landlord don’t need to go back and forth on what the home is worth.

Rent-to-own agreements can last as long as the renter and the landlord agree to, but they typically are put in place from 1 to 3 years.

Here’s what’s usually included in a rent-to-own agreement:

  • The term of the agreement
  • Monthly rent amount
  • Option fee amount
  • Responsibility for maintenance and repairs
  • Purchase price
  • Guidelines for if the tenant doesn’t purchase the home

How Does Rent-to-Own Work for the Seller (Property Owner)?

In a rent-to-own contract, a seller will usually have a tenant pay a bit more in rent than the fair market value. This extra money becomes part of the tenant’s down payment at the end of the rent-to-own agreement. 

Basically, the seller agrees to hold a designated amount of money from each rent payment to go toward the eventual down payment for when the renter goes to purchase the home. Rent-to-own agreements are sometimes used as part of housing programs designed to establish more affordable housing or to revitalize neighborhoods. 

How Does Rent-to-Own Work for the Buyer (Tenant)?

Rent-to-own agreements are a way for a tenant (or renter) to buy a house by renting it first. 

At the end of the rental period, the tenant will have the option to buy the house for the price agreed on in advance. At this point, the renter needs to have documentation from the property owner or landlord that lists the payments they made and how much of that will be applied to the purchase price. The tenant will then get a mortgage just like any other homebuyer. 

Rent-to-own contracts make the most sense for those who know they want to become homeowners but aren’t quite ready financially. A tenant may need time to improve their credit or save for a down payment, and this type of arrangement can provide some breathing room for them while they get their finances in order.

Types of Rent-to-Own Contracts

A typical rent-to-own arrangement has 2 parts: The first is the rental or lease agreement, and the second is the purchase option. The lease agreement is like any other rental contract. It lists the set amount of monthly rent the tenant will pay while they live in and use the home, and it sets the rules around that arrangement, such as what they can and can’t do to the property. The purchase option, on the other hand, gives the tenant the right to buy the home during or at the end of the rental period.

There are also 2 different types of agreements for rent-to-own properties: lease-option agreements and lease-purchase agreements. Both agreements allow a renter to lease a home for a set period of time and then buy the home at the end of the lease. However, there are some differences between these contracts that are important to understand. Let’s explore the 2 types and how they differ.

Lease-Option Agreement

When a tenant signs a lease-option agreement, they usually pay an option fee to the homeowner, so they can buy the home at the end of the lease term. The rent money, also known as rent credit, is money the renter pays over the course of the lease that goes toward the down payment if they choose to buy the home. 

This process usually involves an appraisal to determine how much the home is worth. Most of the time, the option fee reduces the purchase price of the property. If the renter isn’t interested in buying the home, they can walk away from the option fee, which allows it to expire, but they then lose that money along with the rent credits acquired.

Lease-Purchase Agreement

For a lease-purchase agreement, the renter still puts a certain percentage of their rent payments toward a down payment to buy the home. However, it differs from a lease-option agreement as the renter has an obligation to buy the home at the end of the lease.

The renter and the seller will agree to a purchase price when the lease is signed. Setting a price beforehand gives the renter a better idea of how much money they’ll need when they go to take out a mortgage. Selecting a lease-purchase agreement means renters should start shopping around for a loan while living in the home or when a price is agreed upon.

It’s a good idea for a renter to make sure they qualify for a loan during their lease period because if they fail to qualify for a mortgage at the end of the lease (due to their credit score or for other reasons), they’ll give up the claim to the home and all of the rent credit they’ve accumulated. The homeowner can also sue the renter for breach of contract if they don’t buy the home.

How to Find Rent-to-Own Homes

As you look for a rent-to-own home, you should use the same guidelines as you would if you were buying a home. You’ll want to consider things such as the size of the home, the neighborhood, proximity to your job and other important places, and school systems.

There are a variety of ways to find rent-to-own properties. You can start by contacting sellers directly if their home has been on the market for at least 3 months. It’s a good idea to review a rent-to-own contract example before going down this road, so you understand what you’ll be negotiating. 

You can also use RenttoOwnLabs.com to search for rent-to-own properties in your area. An experienced real estate agent can also help you with contacting the landlord and presenting an offer if you do find a potential property. Keep in mind that you’re more likely to find listings for this type of arrangement in smaller cities and towns with less competitive real estate markets.

Rent-to-Own Home Programs

There are also specific rent-to-own programs individuals can participate in to make the process even easier. There are a few national programs to look into, such as Divvy, Home Partners Program, or Dream America. These types of programs help renters find rent-to-own properties as well as assist them in the rent-to-own agreement process.

There may also be an array of programs available in your local area. Do some research online and keep your eyes peeled for billboards or print advertisements. If you pair up with a national or local program, you might just find that rent-to-own is your ideal path to homeownership.

Rent-to-Own Pros and Cons

Rent-to-own agreements may sound like a good idea to buyers who can’t quite qualify for a mortgage yet but want to own their own home in the future. However, rent-to-own homes do come with some potential risks to consider for both the tenant and property owner. Here are some pros and cons to think about before deciding to rent-to-own.

Buyer (Tenant)

ProsCons
It provides a path to homeownership if a tenant can’t immediately qualify for a mortgage.The tenant can lose the money spent on the option fee if they can’t qualify for a mortgage.
It ensures no one else can purchase the home if a tenant falls in love with it.The house could lose value over the lease period.
It can cut down the costs and hassle of moving multiple times.There could be problems with the property that the tenant doesn’t know about until they try to buy it.
The tenant can work on their credit while they rent. The tenant may have less control over certain aspects of the process or the home itself.

Seller (Property Owner)

ProsCons
It can attract more buyers by marketing to renters who hope to buy in the future.The tenant could decide not to buy the home, leaving the property owner to find another tenant or start the sale process over again.
Sellers can earn rental income while moving toward selling a property.Rent-to-own can take time — potentially a few years — which can be a downside if a property owner needs money now.
Owners can ask for a higher sales price when offering rent-to-own.A property owner typically locks in a sales price when they sign a rent-to-own agreement, but home prices might rise faster than expected.
It has the potential to attract higher-quality tenants who will likely have an interest in maintaining the property.The tenant could potentially uncover defects with the property and demand a lower purchase price as a result.

FAQs

Who pays the property taxes on a rent-to-own property?

The current homeowner is legally responsible for all property taxes until the property is officially purchased by the renter. They’re also responsible for any HOA (homeowner association) fees and homeowner’s insurance costs. Sometimes, these costs are passed down to the renter through their monthly rent payments. 

How does lease-to-own work?

Lease-to-own is another term used to describe rent-to-own, depending on how your landlord writes it in the contract. The property owner may describe the agreement as a lease-to-own or rent-to-own, but it essentially means the same thing.

Can I rent-to-own a home with bad credit?

Rent-to-own allows buyers with no credit, bad credit, or those with no money for a down payment to enter into a purchase contract. The rent-to-own option allows the renter to establish a consistent payment history, accrue money for a down payment, and gain equity in the home.

Can you rent-to-own with low income?

There’s no rule or law against those with low income being part of a rent-to-own agreement. It’s ultimately the decision of the landlord or property owner as to whether they allow low-income tenants to rent-to-own. It’s a good idea to ask these questions upfront before moving forward with the initial steps of the process.

Are there alternatives to rent-to-own?

Rent-to-own is a good option for some people who want to buy a home but aren’t quite ready financially, but it’s not a perfect fit for every person. Some alternatives include seeing if you qualify for a low-down-payment mortgage, considering owner financing, or continuing to rent for the time being.

Final Thoughts: Is Rent-to-Own a Good Idea?

Rent-to-own contracts are a unique tool that could make it easier for renters to transition into homeownership if the individual terms and conditions make good financial sense. Like any big decision in life, it pays to read the fine print and fully understand what’s being signed before making a commitment.

This can be an ideal path for those who are on track to pay down other debt and improve their credit scores or for those who need to wait until they have a steady employment history to qualify for a mortgage. But, remember, purchasing a home through a rent-to-own arrangement comes with risks and expenses that a person may not have in a traditional home purchase. It’s best to have a plan of action in place before signing a rent-to-own contract to make sure it’s the best decision!

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