Rent-to-Own Homes: What You Need to Know
Rent-to-own homes give you a path to homeownership if you can’t qualify for a mortgage yet. The seller of the home allows you to rent the home with the option to buy it at a later date and count your rent toward a down payment. However, before you sign a lease-purchase agreement, make sure you understand how it works and the risks involved.
How do rent-to-own homes work?
The terms of a rent-to-own home contract may vary depending on whether the seller is an individual or a company. It’s important to understand that you start these arrangements with the seller as a landlord, which makes you a tenant. Until the lease period expires, you don’t officially start the process to own the home.
Most rent-to-own home agreements include the following steps:
- Decide between a lease purchase or a lease option. A lease-purchase agreement obligates you to buy the home when your rental agreement expires. A lease-option contract gives you the choice to buy the home when your lease is up or just walk away without any financial or legal obligation. If you’re not sure what type of agreement you’re signing, it’s worth it to have a real estate attorney review it.
- Negotiate the sales price. Sellers can agree to sell you the home based on a price that’s set when you sign the purchase agreement or wait until your lease expires. In most cases, the price you agree to will be higher than current market values. The seller wants to make sure they account for future increases in value because the home won’t be sold until your lease agreement expires.
- Negotiate how your rent will count toward the purchase. Some rent-to-own home agreements allow you to apply a portion of your rent toward the purchase price. However, that may involve charging you more rent than you’d pay for a similar rental home without a lease-purchase agreement. Make sure you understand exactly how much rent (if any) is being credited toward the eventual purchase of the home.
- Negotiate the option period. The rent-to-own contract should give you a timeline clearly showing the deadline for buying the house, commonly called an “option period.” Option periods typically range from one to five years. If you don’t exercise your right to buy within that time period, you won’t be able to buy the home and you’ll lose any upfront money you paid.
- Negotiate upfront fees. Sellers that agree to lease-to-own home contracts typically want upfront money to give you the option to buy the home. Often called an “option fee,” the cost can range from a few hundred to a few thousand dollars and is negotiable. It’s usually non-refundable and should be applied toward the purchase price if you buy the home after the lease expires. However, the seller can keep the fee if you default on your rent payments or don’t purchase the home.
- Decide who makes repairs and maintains the home. You may take on the responsibility of a homeowner as part of a lease-purchase agreement. That means you can make custom changes to the home without landlord objections. However, it also means late-night plumbing issues or a leaky roof may be your problem instead of your landlord’s.
- Get a home inspection or appraisal. It’s normal to get a home inspection if you’re buying a home, and while it’s not required as part of a rent-to-own home contract, it’s a good idea to get one so you know what shape the home is in. You may want to consider getting a home appraisal as well to make sure you’re getting a fair price for the home. Keep in mind the seller will usually set the price based on what it will be worth when your lease expires, so it’s likely the home appraisal will be less than what you agree to with a lease-purchase loan.
- Exercise your right to buy. Once your finances are in order or your option period is about to end, you can exercise your right to by using any of the following methods:
- Take out a new mortgage. If you’re preapproved for a mortgage you can buy the home and apply the extra rent and your option fee toward the down payment requirement
- Negotiate a seller-carryback. If you still aren’t qualified for a mortgage, you can ask the seller to become the lender for the amount you need to buy the home. However, you may need to pay additional non-refundable money for a seller-carryback option and pay a higher interest rate than a regular mortgage.
Pros and cons of rent-to-own homes
You can take baby steps toward homeownership with low credit scores and no down payment. A rent-to-own home agreement gives you time to fix spotty credit and save up for a down payment so you can qualify for a mortgage when your lease is up.
You can take the home and the neighborhood for a test drive. By renting before you buy, you’ll have extra time to make sure the home and neighborhood fit your family’s needs. If it doesn’t, you can choose not to buy it. Just make sure you choose a lease-option agreement: You’re legally on the hook to buy the home with a lease-purchase agreement.
You may lock in a better price on the home. If values are on the rise in your area, a rent-to-own contract makes it possible to lock in a price so you’re not at the mercy of the market when your lease is up.
You can try out homeownership. You’re usually responsible for maintaining the home but can also add your own personal touches, which means you’ll get a feel for whether you really want to be a homeowner.
You’ll typically pay more rent than a regular rental home. If you decide you want a portion of your rent applied to a future down payment, expect to pay extra for your monthly rent.
You may pay more for the home than it’s currently worth. Because you aren’t technically buying the home from the outset, rent-to-own home sellers usually demand a markup on the home’s value based on what they think it will be worth when you exercise your lease option.
You could get scammed. The Federal Trade Commission (FTC) warns that rent-to-own scams are more common because you’re dealing directly with the seller of the home without the help of a real estate professional. It may be worth it to pay a real estate attorney to review the agreement, confirm that the seller is actually the owner of the home and check the title for liens or judgments that could result in foreclosure during your lease period.
You might not be able to buy the home within the option period. If your credit or lack of down payment savings are preventing you from getting a mortgage now, make sure you have a plan to qualify by the time your option period expires. Consult with a loan officer and be proactive about steps to get preapproved for a mortgage so you don’t end up losing the money you paid for upfront fees or premium rent.
Is rent-to-own a good idea?
A rent-to-own home makes sense if:
- You need a few more years for your credit to improve after a bankruptcy or foreclosure
- You know your income or savings situation will improve and you can afford to pay more for monthly rent
- You want to lock down the price on a home now rather than waiting until the future
- You’re not sure if you’re ready to own a home
- You’ve consulted with a loan officer and have a strategy for getting a mortgage within the option period
How to find rent-to-own properties
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 three months. Make sure you review a rent-to-own contract example if you go down this road so you understand what you’ll be negotiating.
Although there are online sites that list rent-to-own homes that specialize in larger cities, you’re more likely to find listings for this type of arrangement in smaller cities and towns with less competitive real estate markets.