As a renter, you’ve probably heard of “rent-to-own homes” or maybe “rent-to-own programs.” And if you’re considering making the leap from renter to homeowner, you may be wondering if a rent-to-own home is the right path for you to homeownership. Rent-to-own homes are just one option for buying your first home, but it’s not for everyone.
In this Redfin article, we’ll cover how rent-to-own works, what to look out for, and whether it’s the best option for your homebuying goals. No matter if you’re renting a home in Atlanta, GA, or are looking to buy a house in Boise, ID, here’s what you need to know about rent-to-own homes.
Key takeaways
- Rent-to-own lets you rent a home with the option or requirement to buy at the lease’s end.
- You’ll pay an upfront fee (usually 1-5% of the price) and the purchase price is set when you sign the contract.
- Part of your rent may go toward the down payment.
- Rent-to-own homes can be a good idea for those who need to improve their credit score or save for a down payment.
What is a rent-to-own home?
A rent-to-own home is a residential property that you agree to live in as a rental for a set number of years, with the option to purchase the house at the end of the rental term. With most rent-to-own agreements, part of your monthly rent may be set aside to go toward your future down payment, or you may be required to make an additional payment on top of your rent for this purpose. The rent-to-own contract also includes the purchase price of the home. The tenant may also be responsible for specific maintenance or property upkeep.
How does rent-to-own work?
With a rent-to-own home, you will rent your home for a set term and then buy the home, usually with a mortgage, at the end of the lease period. While it may sound like a simple way to homeownership, there’s more to it than simply going from renter to owner. There are fees, negotiable purchase contracts, and other considerations you should keep in mind when considering a rent-to-own option.
Here’s a list of things you might encounter when exploring rent-to-own homes:
Option fee
At the beginning of your rental term, you’ll need to pay an option fee, which secures your right to buy the home at the end of your lease. This fee is typically 1 to 5% of the home’s purchase price, though there’s no standard rate. It compensates the seller for taking the home off the market and ensures you have the opportunity to purchase it at the agreed-upon price. Many agreements allow you to put your option fee toward your home purchase.
For example, if the purchase price for your property is $100,000, you’ll pay $1,000 to $5,000 before moving in. Sometimes this money is non-refundable and you’ll need to pay this alongside your other upfront fees, such as your security deposit. Keep in mind that these fees are often negotiable, so don’t be afraid to offer different options to your landlord or seller.
Payments toward purchasing
Typically, a portion of your monthly rent is set aside and credited toward the home’s purchase price, as outlined in your rent-to-own agreement. It may be called a “rent credit” or a “rent premium.”
For example, if your monthly rent payment is $1,600, where $1,200 goes toward your monthly rent, and $400 is set aside or “credited” toward the purchase price of the home. If your rental agreement is for two years, you’ll end up having $10,000 ready to be applied to your purchase at the end of your lease.
Your contract should outline where your payments toward purchasing are kept. Ideally, these funds should be held in an escrow account or something similar to ensure they’ll be available to you at the time of purchase. It’s advisable to have your contract reviewed by a real estate attorney.
Types of rent-to-own agreements
There are two types of rent-to-own agreements – lease-option and lease-purchase, let’s explore them.
Lease-option agreement
A lease-option agreement means you’ll rent the home for a set period of time, but have the option to walk away at the end of the lease if you no longer want to buy the home. You’ll typically pay a bit extra in monthly rent in addition to a 2 – 7% option fee. You and your landlord will agree on a purchase price for the home if you choose to buy at the end of the lease. While you’re not required to buy the home, you’ll likely lose the money you put down to secure the option to buy the property.
Lease-purchase agreement
A lease-purchase agreement typically states that you have to purchase the property and your landlord has to sell it to you at the end of the contract. If you fail to purchase the property, you can be sued or subjected to other penalties. You’ll also lose any of the money you’ve already paid toward the purchase. However, in a lease-purchase agreement you may not have to pay an option fee, just additional rent each month that goes toward the purchase price.
Pros and cons of rent-to-own homes
Before committing to a rent-to-own home, it’s important to weigh the pros and cons. Here are some points to consider:
Pros of rent-to-own
Time to improve your credit score: For people with credit score issues, a rent-to-own home can be a great way to pave the path to purchasing your first home. Some lenders work with rent-to-own buyers to help them repair credit and get into the best financial position to buy the house.
Lock in the sale price: Rent-to-own purchases might also offer renters the option to lock in the home’s sale price while giving them time to build good credit and their down payment funds. This can be especially helpful in a rising housing market where home prices might increase over time. However, keep in mind that while the purchase price is set, your future mortgage interest rate is not.
Save on moving costs and get to know the area: Since you’re already living in the home, you won’t have to deal with the expense and hassle of moving again. You also get to familiarize yourself with the property and neighborhood before committing to the purchase. In some cases, you may even have the opportunity to make home improvements that build equity before officially owning the home.
Option to back out of the deal: If you have a lease-option agreement, you can walk away from the deal if the property has issues, your finances change, or you no longer want to buy the home.
Cons of rent-to-own
Additional monthly costs: You’ll likely pay extra in rent each month that goes towards the home’s purchase. While this helps build your down payment, it usually makes rent more expensive than a standard lease, which could be a financial strain.
Potential to lose money: If you’re building credit or saving up to purchase the home, there’s a chance you may not be ready to buy at the end of the lease. If you are unable to buy your home at the end of your agreement, you lose the money set aside in the escrow account.
Paying more than the home’s value: Another potential problem is that the agreed-upon purchase price may be higher than the market value at the time of purchase. If this happens, you’ll have to cover the difference or lose your purchase money.
Responsibility for maintenance and repairs: In many rent-to-own contracts, you’re responsible for maintaining the property and paying for any major repairs. In standard leases, the landlord would cover these costs. However, these are additional costs you may need to factor into your budget.
What is the step-by-step process for rent-to-own homes?
The rent-to-own process is relatively straightforward. Here’s a step-by-step breakdown of how the process works, from finding a property to eventually purchasing the home.
1. Find a rent-to-own property: You can find properties through a rent-to-own program or from an individual real estate investor. You can also work with a real estate agent or brokerage specializing in the rent-to-own market.
2. Get a home inspection and appraisal: You need to do these two things before signing the rent-to-own contract. You’ll also need to do them at the time of purchase to satisfy the requirements of your mortgage lender.
3. Agree on the purchase price: Your rent-to-own agreement will specify the home’s purchase price, so you’ll know upfront what you’ll need to pay at the end of the lease. In most cases, this price is set higher than the home’s current market value. However, if the housing market rises significantly, your locked-in price could end up being a better deal compared to future market prices. On the other hand, if home values decline, you could end up overpaying.
4. Review the rent-to-own agreement: Always have your contract reviewed by a real estate attorney. You should read your contract as well, but an attorney with your best interests in mind will give you the best advice as to whether your contract offers you financial protection.
5. Pay the option fee: Know whether your option fee is applied to your purchase, and don’t be afraid to negotiate the fee. The seller, especially if they’re an individual investor, may be open to lowering the fee if you take on maintenance, for example.
6. Make your monthly rental payments on time: Your contract will require that you stay on top of your monthly payments. If you fall behind on rent, you may forfeit your option to buy, the option fee, or any other money that was set aside for purchasing.
7. Get approved for a home loan near the end of your rental term: If you’re currently experiencing difficulties with your credit score, you may need to create a plan to improve your credit. Your mortgage lender may have free counseling options to help you get in the right place to get approval and pay lower interest costs. You should also work with your lender to determine the best time to start the mortgage process.
8. Purchase your home: If you’ve planned accordingly, you can close on your home at the end of your lease and begin making mortgage payments. Best of all, you don’t need to pay move-in costs or unpack anything because you’re already living there.
Important questions to ask before signing a rent-to-own contract
If you’re considering a rent-to-own home, there are some questions you might ask before you sign your contract:
- Is it a lease-option agreement or a lease-purchase agreement?
- What are the deadlines for when money and other obligations are due?
- What is the purchase price?
- How much of my rent goes toward the purchase price?
- Does the option fee go toward the purchase price?
- Who covers home maintenance?
- Who covers property taxes, home insurance, and other carrying costs?
- Which utilities are my obligation?
- What happens if I walk away?
You might also consider asking some of the same questions renters often ask when renting an apartment or home, like if pets are allowed.
5 common rent-to-own scams
While it’s not pleasant to think about entering into a scam contract, unfortunately, there are rent-to-own scams out there. Here are some common scams and red flags to watch out for.
Scam #1 – The seller doesn’t actually own the home: A common scam is when a person finds a vacant home for sale or rent and lists it as a rent-to-own property with their information. Once you submit an application with your information, upfront fees, or nonrefundable deposits, they may take your information and money and disappear.
Scam #2 – The home is secretly in foreclosure: Once you buy a home, any liens or debts associated with the property are yours. In this case, a homeowner may owe excess money or taxes on the home and sell it to you without you knowing. Now that you’re the owner, you’ll owe these debts.
Scam #3 – The home has undisclosed issues: Another common scam is that the seller doesn’t disclose major issues in the home such as lead paint, mold damage, termites, or asbestos. Sellers are required to disclose this information, making it important to have a thorough home inspection.
Scam #4 – The home is overpriced: Sometimes the home may be priced above market value, meaning you’re paying much more than the home is worth. It’s important to understand what other similar homes in the area cost, so you don’t overpay.
Scam #5 – Unfair contract terms: Some contracts have hidden fees, strict penalties, or clauses that make it easy to lose your option to buy. Always have a real estate attorney review the agreement before signing.
There are other contractual scams that may cause you to lose out on the home or overpay in fees. If you’re considering a rent-to-own home, it’s important to have any contracts reviewed by an attorney.
Is a rent-to-own home right for me?
Rent-to-own may be a good choice if you’re planning to buy a home in the future, but need time to increase your credit score or save for a down payment. It’s also important to consider if you’re going to live in the area for years to come. You’ll want to live in the home long enough to build equity, usually around 3-5 years.
FAQs about rent-to-own homes
How do I find rent-to-own homes?
There are many well-known rent-to-own programs available to prospective renter-buyers. Some common rent-to-own programs include Divvy, Home Partners, and Dream America. These are some larger programs, but there may be other programs that are more tailored to your market. Always do your own research and due diligence when choosing a program.
You can also speak with a real estate agent who may be familiar with any rent-to-own properties on the market.
What alternatives are there to rent-to-own?
Depending on your reasons for looking at rent-to-own homes, there are some alternatives that may suit your goals. One example is down payment assistance programs. These programs can help reduce your down payment or closing cost amount. Down payment assistance programs are available at local, state, and federal levels so you have plenty of options.
Another option is to consider low and no-down payment mortgages. There are several options available like FHA, VA, and USDA loans. Each has varying requirements so make sure to check each program to see if you qualify for these loans.
Should I work with a home seller or a real estate investment company?
When you buy through a rent-to-own agreement, you’ll typically either be buying from an individual home seller (sometimes an individual real estate investor) or through a real estate investment company. There can be advantages and disadvantages to working with either.
When working with an individual, you get the chance to know the seller. The seller will likely be more open to negotiating. You may find it easier to work with the seller versus a company. However, the seller may be less reliable or the relationship might change unexpectedly.
When working with a company, you may benefit from a standardized process. You won’t have to deal with the emotional side of the selling process like you might with an individual seller. But, you’ll find that negotiating is less likely with a company.
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