Interior of Open Floor Plan Dining Room And Kitchen In Rent To Own Home

Rent-To-Own Homes: How Do They Work and Are They Worth It?

Molly Grace9-Minute Read
November 09, 2021

With home prices soaring in many parts of the country, homeownership might feel out of reach for many people. Purchasing a home for the first time is a huge financial obligation. Not only will it require you to save up for a down payment, but you’ll need to make sure you have a good credit score and a low debt-to-income ratio so you can qualify for a mortgage.

All of these things might cause some people to question whether homeownership is the right move for them. However, if you’ve found your dream home, or just want to start taking the needed steps to become a homeowner, you can look into rent-to-own homes.

What Does Rent-To-Own Mean?

You’ve may have noticed advertisements for rent-to-own homes, but what does that term mean?

Rent-to-own is when a legally binding agreement is made to lease a property with the option or requirement of purchasing it after a period of time. Rent-to-own homes are commonly seen among those who may not yet qualify for a mortgage, or who decide not to buy a house and would prefer the option to buy after their lease term ends.

These homes can be a way for potential home buyers to lock in a specific home while they get themselves ready to buy. You’ll start out with a lease that will also include the option to buy before the lease term runs out. Most rent-to-own agreements will have leases that range from one year up to five years. Some rent-to-own home agreements will include slightly higher than market value rent. Each month, a portion of that payment will be put toward a future down payment to buy the home.

During the initial rental period, you’ll be able to start saving for the down payment and making sure your credit is as high as possible. Keep in mind that having your finances in order before buying a home can lead to the lowest possible interest rates on a mortgage. This will drastically reduce the cost of the home over the long term.

How Does Rent-To-Own Work?

Rent-to-own home agreements are not regulated in the United States. Because of this, it’s important to fully understand the contract before signing anything.

Renting-to-own involves more than paying rent and eventually buying the home. The first step is determining and agreeing on the sales price of the home or agreeing to pay the fair market value at the time of the sale. If the purchase price is determined before the agreement is signed, that price is locked in. After pricing is determined, the buyer and seller will draft and sign a rent-to-own agreement.

The rent-to-own agreement is the contract between the seller and the buyer. It spells out the terms of the agreement and should include the following:

  • The sales price of the home or agreement to pay fair market value at the time of purchase
  • Lease term (how long you’ll rent)
  • The amount you’ll pay each month
  • How monthly payments are applied
  • Who is responsible for maintenance and repairs
  • Typical rental terms and conditions
  • Option to purchase, plus the option fee

What’s The Difference Between Lease-Option And Lease-Purchase Agreements?

With rent-to-own homes, there are typically two types of agreements you can enter into: lease-option or lease-purchase.

Lease-option: With a lease-option agreement, you have the exclusive right to purchase the home but can back out after the rental period has expired.

Lease-purchase: You will be obligated by law to purchase the home once the rental period has ended.

When entering into a rent-to-own agreement, you’ll be required to pay an option fee. Let’s dig into what it is, as well as how it’s applied to the final purchase price of the home.

Option Fee

To go along with the signed agreement, the renter pays a one-time, nonrefundable fee that gives them the right to buy the house by the time the lease ends. This is known as the option fee, option premium or option money. It ensures you have “first dibs” on the home. No one else can purchase the property during the lease term.

If you decide to buy the home, the option fee is applied to the purchase price. If you decide not to purchase the home, you will not get that money back. The amount you pay varies and is negotiable but is typically around 5% of the sales price.

Applying Payments

In a rent-to-own arrangement, your monthly payment is usually above the fair market rent value to take into account both the cost to rent the property and the cost to help pay down the purchase price. Here’s is an example of how that works:

The buyer and seller agree to a purchase price of $250,000 with a lease term of 3 years. The seller agrees to pay 25% of the $1,500 monthly rent toward the purchase price. Each month, $375 is applied to the purchase price, lowering the price of the home for the buyer. At the end of 3 years or 36 months, $13,500 is paid toward the purchase price of the home. When it is time for the buyer to purchase the home, the final purchase price would be $236,500.

How Can I Find Rent-To-Own Homes?

You can find rent-to-own properties on many online listing sites, but these listings are typically sparse depending on where you’re looking. Another option is to look for homes that have been on the market for a long time. Many sellers will offer rent-to-own if they are having trouble selling. If you are renting a home you love or if the landlord has decided to sell, talk to your landlord about considering a rent-to-own option.

Pros Of Rent-To-Own Homes

Your financial situation and goals will help you understand if entering into a rent-to-own agreement is the best choice for you, but let’s look at some general benefits of renting-to-own:

For The Buyer

  • You get to test drive the home and neighborhood. Before you actually enter into an agreement to purchase the home, you can use the rent-to-own scenario as a way to find out if the neighborhood and home are the perfect fit.
  • You’re building equity. Each month the portion of rent being applied to the purchase price is helping you build equity in the home. This typically wouldn’t happen when you’re renting.
  • Potential to lock in the sales price. If your rent-to-own agreement includes a set purchase price, you can take advantage of any appreciation to home prices.
  • You can lock in your desired home and still work to improve your finances. After entering into a rent-to-own agreement you’ll have several months to save for a down payment, improve your credit score, and pay down any existing debt.

For The Seller

  • Easy way to sell during a buyer’s market. During a buyer’s market, you’re able to have a seller lined up without worrying about actually putting it on the open market.
  • You can still earn income until the sale. While the buyer is still in the rental period, you can still be bringing in extra income.
  • The renter has stakes in the home. Since the buyer is agreeing to buy or at least has the option to buy the property at the end of their lease, they have invested interest in the upkeep of the home.

Cons Of Rent-To-Own Homes

Similar to understanding the different pros you need to consider before entering into a rent-to-own agreement, you also need to think about the cons.

For The Buyer

  • Late payments can void your agreement. If you’re late on a monthly rent payment you could be in a situation where you void your rent-to-own agreement. This could cause you to lose any money paid toward the purchase price of the home.
  • Home appraisal could differ from agreed-upon purchase price. If the appraisal price of the home is lower than the agreed upon price, you might be unable to secure a mortgage or you’ll need to pay the difference in price out of pocket.
  • Potential that you might not be able to afford the sales price. If your rent-to-own agreement states that you’re willing to pay the appraised value of the home and prices are appreciating, you might not be able to afford the home at the end of the rent-to-own contract period.
  • Lease-purchase agreements require you to buy the home. If you sign a lease-purchase agreement, you’ll legally be required by law to purchase the home.

If you’re interested in a rent-to-own property, be cautious of a few common rent-to-own scams and know how to avoid falling for them. Always ask for documentation proving the seller owns the house, so you aren’t paying upfront fees to someone who can’t actually rent to you. Such documents include a recent tax bill, mortgage statement, purchase documents or property title.

Work with a real estate attorney to review your agreement before you sign it. They can help you understand your rights and any penalties laid out in the contract for late or missed payments. Schedule a home inspection before you sign the agreement so you don’t get stuck having to purchase a home that may need a ton of repairs.

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For The Seller

  • Difficult to exit contract: If you’ve entered into a rent-to-own contract but you decide you want to either reoccupy the home or sell it on the open market, you’ll find it difficult to do.
  • You might not be able to realize appreciation: If the rent-to-own agreement you put together includes a locked in purchase price, you might eliminate the ability to take advantage of any further appreciation in home prices.

The Bottom Line

If you’ve been thinking about purchasing a home, but you’re worried about rising home prices, you might be considering a rent-to-own home. Not only could it allow you to lock in a home at a price that fits your budget, but you’ll get a little extra time to save up for a down payment and get your finances in order.

Before you make a decision, make sure you weigh all the pros and cons, and check out a home affordability calculator to see if it would make more sense to purchase a home today.

Molly Grace

Molly Grace is a staff writer focusing on mortgages, personal finance and homeownership. She has a B.A. in journalism from Indiana University. You can follow her on Twitter @themollygrace.