How Does Rent-To-Own Work?

Rent-to-own offers a path to homeownership for those who can’t get a traditional mortgage right away. It lets you rent a home with the option or requirement to buy it later, typically within 1-3 years. Part of your rent may go toward a down payment, helping you save while living in the home. This article explains how rent-to-own works, its types, benefits, risks, and tips to make an informed decision.

What is Rent-To-Own?

Rent-to-own, sometimes called lease-to-own, is an agreement where you rent a property with the possibility or obligation to purchase it at the end of the lease term. During the rental period, a portion of your rent, known as rent credit, may be set aside for the down payment. You might also pay an upfront option fee to secure your right to buy the home later. This setup is ideal for those needing time to improve their credit score or save for a down payment.

Types of Rent-To-Own Agreements

There are two main types of rent-to-own contracts, each with distinct terms:

1. Lease-Option Agreement: This gives you the choice to buy the home at the end of the lease. You pay a non-refundable option fee, typically 1-7% of the home’s value. If you decide not to buy, you may lose this fee and any rent credits.
2. Lease-Purchase Agreement: This requires you to buy the home at the lease’s end. Not following through could lead to legal consequences, so it’s a bigger commitment.

Understanding the agreement type is crucial, as it affects your obligations and risks.

How Does Rent-To-Own Work?

Here’s a step-by-step look at the rent-to-own process:

1. Find a Rent-To-Own Property: Search for homes listed as rent-to-own through real estate agents, online platforms like Zillow, or rent-to-own companies.
2. Negotiate Terms: Agree with the seller on the lease term (usually 1-3 years), monthly rent, option fee, and purchase price. The price can be set upfront or determined later based on market value.
3. Pay the Option Fee: This one-time fee, often 1-7% of the home’s value, secures your right to buy. It’s non-refundable but may apply to the purchase price.
4. Pay Monthly Rent: Rent is typically higher than market rates, with a portion (rent credit) saved for the down payment. For example, $300 of a $1,800 rent might be credited.
5. Maintain the Property: You may be responsible for repairs and maintenance, depending on the contract. Clarify this upfront.
6. Decide to Buy: At the lease’s end, you choose to buy (lease-option) or must buy (lease-purchase). Use the option fee and rent credits toward the down payment and secure a mortgage for the rest.

Example Scenario

Imagine a $200,000 home with a 3-year lease. You pay a 5% option fee ($10,000) and $1,800 monthly rent, with $300 per month credited toward the down payment. After three years, your rent credits total $10,800 ($300 x 36 months). Combined with the option fee, you have $20,800 to apply to the purchase. If the mortgage requires a 10% down payment ($20,000), your credits cover it, possibly with extra for closing costs.

Pros and Cons of Rent-To-Own

Rent-to-own has advantages and drawbacks. Here’s a breakdown:

Pros

• Build Equity: Part of your rent goes toward owning the home, unlike regular renting.
• Time to Improve Credit: You can work on your credit score while living in the home, increasing mortgage eligibility (Bankrate).
• Locked Purchase Price: If the home’s value rises, you may buy at a lower, pre-agreed price.
• No Bidding Wars: The home is reserved for you, avoiding competition with other buyers.

Cons

• Higher Rent: Monthly payments are often above market rates due to rent credits.
• Risk of Losing Money: If you don’t buy, you may lose the option fee and rent credits.
• Maintenance Costs: You might handle repairs before owning, adding expenses.
• Limited Choices: Rent-to-own homes are less common, reducing options (NerdWallet).

Some, like Ramsey Solutions, argue rent-to-own is risky due to potential overpayment or seller legal issues, while others see it as a practical step toward homeownership.

Is Rent-To-Own Right for You?

Rent-to-own may suit you if:

• You can’t qualify for a mortgage now but expect to soon.
• You want to live in the home while saving for a down payment.
• You’re comfortable with maintenance responsibilities.

It may not be ideal if:

• You’re unsure about staying in the area long-term.
• Higher rent payments strain your budget.
• You’re concerned about the home’s value dropping.

Consider your financial stability and long-term plans before committing.

How to Find Rent-To-Own Homes

Finding rent-to-own properties requires targeted searching. Options include:

• Real Estate Agents: Some specialize in rent-to-own deals and can guide you.
• Online Platforms: Websites like Zillow, Trulia, or Rent to Own Labs list available homes.
• Rent-To-Own Companies: Firms like Home Partners of America or Divvy buy homes and offer rent-to-own contracts, often with support like credit counseling (Bankrate).

Tips for Entering a Rent-To-Own Agreement

To protect yourself and make the most of rent-to-own, follow these steps:

1. Consult a Real Estate Attorney: Have a lawyer review the contract to ensure it’s fair and complies with local laws (Illinois Legal Aid).
2. Get a Home Inspection: Check for issues that could affect the home’s value or require costly repairs.
3. Understand All Terms: Clarify maintenance responsibilities, late payment penalties, and how the purchase price is set.
4. Verify the Seller: Ensure the seller owns the property and is current on taxes and mortgages to avoid scams (Zillow).
5. Plan for the Future: Start improving your credit and saving early to secure a mortgage.

Avoiding Scams

Be cautious of:

• Sellers offering homes they don’t own.
• Properties in foreclosure not disclosed.
• Overpriced homes or strict terms that risk your investment. The Federal Trade Commission warns that rent-to-own deals can lead to financial loss if not carefully vetted.

Frequently Asked Questions

1. What happens if I don’t buy the house?
   • In a lease-option, you can walk away but may lose the option fee and rent credits. In a lease-purchase, you’re obligated to buy, and failing to do so could lead to legal action (Bankrate).
2. Can I negotiate the terms?
   • Yes, you can negotiate the option fee, rent, rent credit, and purchase price with the seller (Progressive).
3. Who handles repairs and maintenance?
   • It depends on the contract. Some make tenants responsible, while others assign certain repairs to the landlord. Clarify this in writing.
4. How is the purchase price determined?
   • It’s either set at the lease’s start or based on market value at the end. Ensure the method is clear in the contract (Investopedia).
5. Can I back out of the agreement?
   • In a lease-option, you can opt out, losing fees paid. In a lease-purchase, backing out may have legal consequences.

Conclusion

Rent-to-own can be a helpful way to achieve homeownership if you’re not ready for a mortgage but are committed to a specific home. It offers time to build credit and save while living in the property. However, it comes with risks like higher rent and potential financial loss if you don’t buy. By understanding the process, reviewing contracts carefully, and planning ahead, you can decide if rent-to-own is the right step for you.