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Smart Money

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

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?

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.

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

The renter may be able to negotiate the contract to put some of this fee toward their down payment. 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

Rent-to-own laws vary by state, and there are different ways to structure contracts between the seller/homeowner and the renter. The homeowner and the renter must agree on purchase price and record that price in their contract. The agreed-to purchase date may be several years in the future. Some contracts allow for an appraiser to reevaluate the value of the house at the time of purchase. 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)?

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.  The renter’s payment is usually higher than it would be in a standard lease agreement, because part of their rent is funding a down payment for the house.

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. During the term of their rent-to-own lease, a renter can work to improve their credit score and improve how they manage their finances.

Types of rent-to-own contracts

In a rent-to-own lease, 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, but there are differences. 

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

When a renter enters a lease-purchase agreement with a homeowner, the renter still signs a lease. During the course of the lease, a certain percentage of their rent payment is applied to a down payment on the home. A lease-purchase agreement is different from a lease-option agreement. At the end of the lease-purchase agreement, the renter is obligated to buy the home. 

The two parties will agree to a purchase price for the home when they sign the lease. Renters should start evaluating financing options as soon as they sign the lease.

Renters should maintain good credit scores during their lease period and make sure they can pre-qualify for a loan. If the renter can’t secure a mortgage, they may not get rent credit and may lose their rights to the home. If the renter fails to buy the home, the homeowner could also pursue legal action against them.

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 home’s value may decrease.
It gives a renter stable housing.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
Owner can have a consistent tenant.The renter may back out of buying the house if they can do so contractually.
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.The agreement may not account for how quickly home prices rise.
It has the potential to attract higher-quality tenants who will likely have an interest in maintaining the property.If the tenant discovers issues with the property while renting, they may negotiate a lower purchase price.

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. The homeowner has to pay homeowner’s association fees and homeowner’s insurance. The renter isn’t directly responsible for these expenses.

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?

For renters who want to pay down debt and improve their credit scores prior to buying a home, rent-to-own may be a viable option. Before entering into a rent-to-own contract, it pays to read the fine print and fully understand what’s being signed before making a commitment.

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