Many people dream of becoming homeowners, but it’s a less attainable goal for some than it is for others. Factors like a low credit score or lack of a down payment can prevent you from obtaining a mortgage loan. And, without one, your home buying prospects are few and far between. You may be stuck waiting until you’ve saved up enough money to put down or working to improve your credit score, which both take time.
But if you’re hoping to own a home sooner rather than later, renting to own is an alternative option you can explore. Find out how rent-to-own agreements work and their pros and cons.
What Is a Rent-to-Own Agreement?
A rent-to-own agreement is when you rent a home from a seller with the intention of purchasing the property at the end of the lease. Each month, you pay an additional fee on top of your monthly rent that goes toward your down payment for the home.
Rent-to-own arrangements only work when both you and the homeowner are on the same page. It’s strongly recommended that you have a formal rent-to-own contract that outlines the rights and responsibilities of both you and the home seller. This will help to avoid disputes, solidify the financial details of the deal, and back up your claims in the event of a legal issue.
In your contract, you and the homeowner need to decide on four main points: the purchase price, rental payments, home maintenance, and option fees.
The purchase price of the home can either be a fixed price at the time the contract is created, or it can be decided when the lease expires. Regardless of when you and the home seller decide to name a sales price, it should be based on typical residential property pricing factors, such as the real estate market, condition of the home, and its location.
The rental payments you make during a rent-to-own lease need to cover both regular rent to live in the home, as well as an additional amount to be put toward your down payment. Both you and the home seller need to agree on a set monthly payment amount, which will typically be higher than the going rate of rents in your area because you’re adding in the cost of the down payment.
Just make sure that your monthly rent payments are still affordable. Otherwise, you may be better off setting the additional amount aside on your own to save up a down payment for a traditional home purchase down the road.
Often in rent-to-own agreements, home maintenance and upkeep are your responsibility as a potential buyer. Maintenance can mean everything from mowing the lawn and shoveling the walks to replacing an appliance or repairing a leak. The home seller is still responsible for property taxes, property insurance, and mortgage payments.
Review your agreement carefully so you know which maintenance tasks and costs you need to cover.
Many rent-to-own agreements include an option fee. This is a one-time, non-refundable fee that you pay to the seller in order to secure the option of purchasing the home in the future. It’s usually between 1% and 5% of the agreed-upon purchase price of the property.
Option money is essentially what you give to the home seller in exchange for allowing you to purchase the home at the end of your lease. Without it, there’s no legal consideration in the contract, which can make it difficult to hold the homeowner to the terms of the agreement if a dispute arises.
How Does Rent-to-Own Work?
The gist of rent-to-own is relatively straightforward. You put down an option fee to retain the right to purchase the home when you sign a lease, which is usually for three to five years. You pay both monthly rent payments to live in the property and an additional amount that goes toward your down payment for the home.
Depending on whether you signed a lease-option or lease-purchase agreement, you will either have the option to buy the home or be legally obligated to do so once your lease expires.
Lease-option agreements provide you with more leeway when it comes to a rent-to-own contract. If you choose not to purchase the home, you’ll be able to walk away from the property with no additional legal responsibilities, although you will likely lose the option fee and additional rent payments that you made.
If you choose to purchase the home, any deposits or payments you made toward purchasing the property will be applied to your down payment.
Lease-purchase agreements, however, are much less flexible. Depending on the contract you signed, you may be required to purchase the home at the end of your lease term — whether you can afford to or not.
Typically, any money you put toward the property during the rental period, either as a lump sum or in the form of rent credits, is forfeit if you decide not to buy.
It’s beneficial to have a real estate lawyer review your contract before you sign it so you know exactly what you’re getting into. They’ll help you to interpret any confusing legalese and ensure you’re using the right type of agreement for your situation and goals.
Pros of Rent-to-Own
In the right circumstances, renting to own comes with a lot of benefits for those who want to own a home but who aren’t able to move through a typical home buying process.
If you’re hoping to buy your own home but can’t get a preapproval from a lender or your credit score needs some TLC, here’s what a rent-to-own agreement can offer you.
1. It Gets You Into a Home Faster
If you really want to buy a home, but poor credit history or lack of a down payment are keeping you from reaching your goal, rent-to-own will get you into a home sooner. You can begin your journey toward homeownership while you build up your credit score and save a down payment instead of having to do so before you find a property.
For example, if you have bad credit, you might be holding off on taking out a mortgage until you’ve improved your credit score so that you qualify for a lower interest rate. When you rent-to-own, you’re able to work on your credit and get your finances in order while living in the home you want to buy.
2. It Gets You Into a Home You Might Not Qualify for Right Now
Just because you don’t meet the requirements to buy a home now doesn’t mean you won’t in the future. Rent-to-own agreements help you to lock in the option to purchase a home in the future, even if you don’t currently qualify to buy it.
This is especially helpful in competitive markets where you want to take advantage of affordable home prices and properties for sale while they’re available.
For example, one of the best times to purchase a home is in a buyer’s market, where there are lots of homes for sale and sellers are more willing to consider alternative options, including rent-to-own contracts.
3. It Can Lock in a Purchase Price
Locking in a purchase price while negotiating your rent-to-own contract can end up benefiting you in the long run, especially if the property value increases over your lease period. No matter how much other homes in the area are selling for, and regardless of any fluctuations in the market value, you won’t have to pay any more than the sales price you originally agreed to.
4. It Lets You Test Drive a Home Before Buying It
Traditional homebuyers don’t often get a chance to live in a home before they buy it. But, in a rent-to-own agreement, you’ll get to do just that. You’ll have a rare opportunity to get a feel for the home and neighborhood before you commit to living in the property for an extended period of time.
Living in the home brings its features and failures to the forefront, allowing you to make an educated and informed decision about whether you want to buy it.
5. You’ll Have to Move Less Often
Often, rent-to-own agreements allow for longer rental periods than typical rental agreements. This is so that you have enough time to build up an acceptable down payment without having to pay exorbitant monthly rent payments.
With longer lease terms comes the benefit of being in a single property for more than a year at a time. Less moving means fewer relocation costs and predictable rent payments.
6. Your Monthly Payments Build Equity
One of the downsides of being a renter is that your monthly payments don’t build equity in the home. But, when you rent to own, a portion of your payment goes toward purchasing the home. You begin to build equity in the property without the commitment of buying it right off the bat.
Over time, that equity builds up, and by the end of your lease term, you should have a suitable down payment.
Cons of Rent-to-Own
While renting to own does come with benefits, it also has its downsides. It’s an uncommon way to buy a home and should only be used if it makes sense for you and your personal finances. Before signing a rent-to-own agreement, review these cons to get a clear picture of what to expect.
1. The Monthly Payment Is Typically Higher Than Renting
When you rent to own, you have to pay regular rent as well as an additional fee that goes toward your down payment. This makes your monthly payments higher than typical rent costs in your area.
How much extra you have to pay depends on the length of your lease and the amount of the down payment. You can expect your rent payment to be an average of 25% higher than the going rate where you live, which can drastically affect your budget and cash flow.
2. Most of Your Monthly Payment Doesn’t Go Toward the Purchase Price
If only 25% of your rent payments are going toward a down payment, that means the remaining 75% is simply covering the cost of renting the home. Unfortunately, if you’re only putting a couple hundred dollars aside each month, it’s going to take a long time to build up a suitable down payment — usually 3% to 20% of the purchase price — needed to get a mortgage.
For example, let’s say $250 of your monthly rent payment goes toward equity and you need a $10,000 down payment. It would take you just over three years — or 40 payments — to save up enough to move forward with purchasing the home.
And, if you decided not to buy at the end of your lease, you would forfeit that money.
3. Options May Be Limited
Rent-to-own agreements typically offer more benefits to buyers than to sellers. Because of this, it may be hard for you to find a home seller who’s willing to offer you a rent-to-own purchase contract.
That’s especially true if you’re looking in a competitive market. You may be forced to look for homes in less desirable areas or that have fallen behind on maintenance and upkeep.
4. You Pay Nonrefundable Upfront Fees
If you’re exploring rent-to-own arrangements because you’re low on cash, you should know that there are still upfront fees. The option fee you pay to secure the option to buy the home at the end of your lease has to be paid when you sign the agreement.
Because it’s typically between 1% and 5% of the purchase price, that can add up to a sizable amount of cash. For example, if you were buying a home for $250,000, and the option fee was 2.5% of the purchase price, you would need to give your landlord $6,250 upfront.
If you’re already struggling to save up enough for a traditional down payment, an option fee may be out of reach.
Aside from the option fee, you might also need cash upfront to pay for a home inspection and appraisal. It’s recommended that you get a home inspection and appraisal before you sign a rent-to-own contract, which you’ll have to pay for yourself.
5. You May Be Responsible for Repairs and Upkeep
Some rent-to-own agreements put maintenance and upkeep costs and responsibilities on you instead of the home seller. That means potentially covering expenses related to:
- Landscaping and lawn care
- Replacing or repairing appliances
- Exterior siding
If you don’t have the cash to cover unexpected expenses, like an emergency fund, you could end up going into debt just to hold up your end of the bargain.
6. Late Payments Can Really Hurt You
Late rent payments in a rent-to-own arrangement come with major consequences. If you make a late or incomplete payment, you risk voiding your contract altogether. This means not only losing any equity you’ve paid into the home but your option to purchase as well.
7. You Could Lose Money If You Decide Not to Purchase
The option fee you give to your landlord when you sign a rent-to-own agreement is nonrefundable whether you decide to buy the house or not. Because this can be anywhere from 1% to 5% of the purchase price, walking away means losing a significant chunk of cash that won’t go toward your equity in a home.
On top of that, many rent-to-own agreements stipulate that, if you decide not to buy, you’ll also lose any equity you accrued through your increased rent payments.
8. Home Value Could Decrease
Regardless of what the market is like when you make your rent-to-own agreement, there’s always a chance that the value of the home could change during your rental period. If it goes up, you’re in luck. But, if it goes down, you’re locked into a purchase price that’s higher than the home’s actual value.
Because rent-to-own agreements are typically longer than a standard one-year lease, it’s impossible to predict what the market will look like when your agreement ends. The real estate market is unpredictable and even volatile at times, so you’ll be taking a risk no matter when you sign.
9. You Have Less Control
In a rent-to-own agreement, the home seller is still responsible for paying the mortgage. Unfortunately, you have no control over whether they actually do or not. If the property forecloses, not only will you lose your rental property, you also won’t have the option to buy it anymore — unless you can afford to purchase it as a foreclosure.
10. You May Not Qualify for Financing When the Lease Is Up
One of the benefits of rent-to-own is that it gives you time to improve your credit score and save up for a down payment. But, if you don’t amend these issues during your lease period, or if your financial situation gets worse, you may not qualify for financing from a mortgage lender.
If you don’t qualify for a mortgage and can’t pay the purchase price when your lease is up, you can’t buy the property, regardless of how much equity you’ve put in.
11. It’s Less Flexible Than Renting
Think of renting-to-own as a mix between a traditional tenancy and homeownership. Where renting is typically flexible, a rent-to-own agreement is not.
For example, if you need to break a lease to relocate you always have that option. But it’s much harder to get out of a lease-purchase agreement.
This means you have to be committed to living in that home for an extended period. If anything changes, it may be difficult to find a workaround.
12. Scams Are Out There
Unfortunately, there are all kinds of rent-to-own scams out there, and they can be hard to identify. Some ask for option fees upfront for a nonexistent property while others fail to disclose major issues within the home, like structural damage or mold.
Make sure you know who the legal homeowner is and protect yourself by getting both a home inspection and appraisal. Work with a real estate attorney to confirm the legal status of the property (such as whether it’s in foreclosure) and don’t hand over any money until you have a signed contract.
When Is Rent-to-Own Worth It?
Rent-to-own will only benefit you in certain circumstances. Before you decide to move forward, make sure that:
- You’re confident your financial situation will improve by the time your lease is up.
- You have a plan to build or repair your credit score.
- You plan to live in the same area for at least five years.
- You don’t plan to make any major career changes.
- You don’t qualify for a traditional mortgage.
How to Find a Rent-to-Own Property
Although finding a rent-to-own property can be difficult, here are some tips for connecting with home sellers who are willing to consider it as an option:
- Work With a Real Estate Agent. Even though you’re technically renting the house to begin with, you should still go through a realtor. They’ll have an idea of which home sellers are willing to consider a rent-to-own agreement and can help you to create a solid contract. Some agencies even have internal rent-to-own programs.
- Negotiate With the Seller. If you find a great property but aren’t sure whether the seller would be willing to enter into a rent-to-own agreement, there’s no harm in asking. This works best for homes that have been listed for a long time or in a buyer’s real estate market.
- Find a Reluctant Landlord. Not all landlords rent out their homes because they’re passionate about renting. If you have or come across a reluctant landlord who you think may be interested in offloading the property, approach them with a rent-to-own proposal.
- Find a Pre-Foreclosure Property. Homeowners who are struggling to pay their mortgage are more willing to explore their options, including selling to you on a rent-to-own basis. It can be a win-win situation because you’ll have a rent-to-own property and they’ll be able to work toward repairing their credit and finances.
- Ask Your Network. There’s no harm in reaching out to your network to let them know what you’re looking for. You could have a friend or family member who knows someone looking to sell a home and who might be willing to work with a buyer referred by a mutual contact.
- Look in Inactive Areas. You’re more likely to find rent-to-own properties in inactive real estate areas. This may mean homes outside of the city or in small towns, where the market is slow.
- Search Online. Many classified services sites like Craigslist allow both landlords and home sellers to post ads, some of which are willing to work with a rent-to-own agreement. Search listings for “rent-to-own” to see what comes up.
Alternatives to Rent-to-Own
If renting to own doesn’t seem like the right choice for you, you aren’t completely out of luck. You can still work toward becoming a homeowner by:
- Applying for an FHA Loan. If your finances are in good shape and all that you’re missing is a lump sum down payment, a Federal Housing Administration (FHA) loan may be the way to go. Their down payment requirements are as little as 3.5% for buyers with a credit score of 580 or higher.
- Continuing to Rent While Saving Up a Down Payment. Even though you want to be a homeowner sooner rather than later, continuing to rent while you save up a down payment could just be the best option for you. Instead of paying an additional rental amount to a rent-to-own landlord, set the money aside on your own until you have enough for a down payment and a traditional mortgage.
- Wait Until You Improve Your Credit Score. A low credit score shouldn’t be the only reason you choose renting to own. If it is, waiting until you improve your credit is likely your best bet. Improving your credit score won’t only help you to get a mortgage, either. It also comes with other benefits, like a lower interest rate on your home loan and a better preapproval.
When it comes to renting-to-own, the bottom line is that it has to be a good choice for your personal financial situation. Before signing any kind of agreement or putting down any money, make sure to:
- Determine whether you want a lease-purchase or lease-option agreement.
- Get a home inspection and appraisal.
- Have a real estate attorney or real estate agent review your contract.
- Read the fine print and ensure you understand your responsibilities and obligations.
By doing your due diligence and covering all your bases, you’re more likely to have a positive and successful rent-to-own experience.