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Rent-to-Own Homes: How Do They Work?

You have your eyes set on homeownership. But houses these days are crazy expensive–so much so that maybe trying to save for a big enough down payment or apply for a mortgage has been a challenge.

At this point, choosing a rent-to-own (or lease-to-own) home might sound like a good alternative to buying a home the traditional route. But rent-to-own can be risky—especially for buyers.

To help you make a smart decision on your homeownership journey, we’ll explain exactly how rent-to-own homes work and help you weigh the pros and cons.

What Is a Rent-to-Own Home?

A rent-to-own home is a house you can buy through a rent-to-own agreement. With this type of contract, you agree to rent a property for a specific time period before gaining ownership.

The time period can range from several months to several years, depending on the specifics of the contract.

During that time, the seller agrees to hold a designated amount of money from each rent payment to go toward your equity (the portion of the home you’ll own as opposed to what you’ll owe) when you purchase it.

Types of Rent-to-Own Agreements

There are two different types of rent-to-own agreements:

  • Lease option agreement. This gives you the option of purchasing the home after the agreed-upon time period.
  • Lease purchase agreement. This one legally obligates you to purchase the house after your lease term is up.

How Does Rent-to-Own Work?

The rent-to-own process works much differently than the typical home-buying process—other than the fact that you’d still be working with the property owner to sign a contract.

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Since everything from the purchase price to closing costs is negotiable with a rent-to-own home, the process can get a bit tricky.

To get an idea of what the process is like, here’s what most rent-to-own transactions involve:

1. Negotiate a Purchase Price Before or After Renting

The rent-to-own agreement will specify how and when the purchase price is decided. The price could be based on the home’s current value—or a predicted one.

In some cases, the price becomes official when the buyer and seller sign the contract. In other situations, the purchase price won’t be decided until the lease expires.

2. Determine if Rent Payments Include Money Set Aside for the Purchase

As part of the contract, you’ll agree to pay a certain rent amount each month. These payments are typically higher than rent prices in the area because a percentage of each payment is set aside as a credit for your future purchase of the home.

3. Ask if Repairs and Upkeep Are Your Responsibility While Renting

In a rent-to-own agreement, the seller may ask you to cover costs such as repairs, maintenance, HOA fees and property taxes while you’re renting.

You could be on the hook for everything from landscaping to a broken air-conditioning unit.

That’s why it’s so important to walk through the contract with an attorney who can clearly explain what each party is responsible for.

4. Pay an Up-Front Fee to Secure Your Option to Buy the House

You’re required to pay the seller a one-time, nonrefundable fee—usually known as option money, option fee or option of consideration.

This gives you the opportunity to buy the house, and in some cases, the seller will agree to put this amount toward your equity in the home.

There’s no standard option money amount—it’s typically a percentage of the home’s purchase price.

5. Agree on a Lease Term That Leads Up to the Purchase

You and the seller will agree to a specific lease term in the contract. If the lease ends and you either decide not to move forward with the purchase or you’re unable to qualify for financing, the option to purchase will expire.

6. Transition From Renting to Buying the Home

Unless you save up enough cash to buy the house outright while renting, you’ll need to secure financing at the end of the lease term if you plan to purchase the house.

At that point, your mortgage lender will set a closing date where you’ll be given ownership of the property as the buyer. Depending on the terms of the agreement, the percentage of rent money set aside for your purchase and/or option money will be credited to you.

Keep in Mind: Everything Is Negotiable

Because the rent-to-own process is less regulated than a typical buying or rental process, there’s no standard rent-to-own contract. The terms are completely negotiable.

If you’re entering into a rent-to-own process, you need to talk to a trusted real estate agent and an attorney on the front end to make sure you understand—and are okay with—the terms of your unique contract.

Is It a Good Idea to Do Rent-to-Own?

Rent-to-own may sound like a good idea to buyers who can’t quite qualify for a mortgage yet, but want to get their foot in the door—literally!

The downside is rent-to-own comes with big risks to consider. So let’s dig into the pros and cons before you decide to do one.

Pros for Buyers

You Build a Down Payment Over Time

Instead of having to fork over a significant down payment when you move in, you build equity over a specific period of time by paying higher rent.

You Can Avoid Buyer Competition

At the end of the rent-to-own agreement, you won’t be up against other buyers for the property.

You Don’t Have to Qualify for a Mortgage Right Away

You may be drawn to a rent-to-own program because you can’t afford to buy a home yet. Maybe you’re still paying off debt or you don’t have a down payment saved.

Moving into a house without qualifying for a mortgage may seem like the answer. But here’s the truth: The chances of your rent-to-own agreement falling through go way up if you’re already in a financial mess.

Cons for Buyers

Your Rent Will Be More Expensive

Even if your contract is set up so that part of your rent is going toward equity in the home every month, your rent prices will be higher because of that.

Why not just rent a place for less money and keep the money you’re setting aside for a down payment in your own bank account instead of your landlord’s?

You’ll Pay Extra for Fees and Repairs

Remember—you’ll have to pay that up-front fee (see #4 above) in order to have the option to purchase the home down the road. You probably won’t get that back if the deal doesn’t work out.

And don’t forget—you may be responsible for all repairs and upkeep even while renting. Unexpected emergencies can put a serious hole in your pocket—for a house that isn’t even yours yet!

You Could Pay More Than the Home Is Worth

If you have a rent-to-own contract for a couple years, you have no way of knowing what the real estate market or local economy could do during that time.

Sure, your home value could go up, but it could also drop. The purchase price you lock in at the start of the contract is usually inflated to account for rising home values.

That means you could end up paying more than the property is actually worth!

You Lose Money if You Decide Not to Purchase the House

Let’s say you get a new job that requires you to relocate. Or maybe you still can’t qualify for a mortgage at the end of the contract term. Perhaps you just decide this house isn’t for you.

If you’re in a lease option agreement, you can walk away from the contract. But what happens to all of the cash you forked over in higher rent and option money? That’s thousands of dollars you won’t get back.

The Contract Favors the Seller

Something as small as a late rent check or not paying for a repair in a "timely manner" could release the landlord from any obligation to honor the contract. There won’t be a knight in shining armor headed your way to save the day—or your contract.

You Could Lose the Equity You Build

If the landlord’s financial situation changes and the house goes into foreclosure, that house goes to the bank—not to you.

Or if the seller just up and changes their mind after they’ve signed a rent-to-own contract, it would take expensive legal action to enforce the contract in that scenario. That’s a cost you may not be able (or willing) to pay.

Bottom Line: Is Rent-to-Own Worth It?

While a rent-to-own agreement is a legally binding document, it has way too many loopholes to be a guarantee. Plus, you lose so much money in the process if the deal goes sour.

So keep your money in your own bank account and steer clear of rent-to-own contracts—they’re not worth it!

Alternatives to the Rent-to-Own Process

When it comes to rent-to-own homes, the cons outweigh the pros. If you want to make a smart decision for your future, it’s simple: Avoid a rent-to-own situation, even if it means you have to wait to move.

Trust us—it’s worth it to buy a house the smart way. If you need time to clean up your finances, that’s okay.

Here’s what to do:

  • Keep renting. There’s no shame in renting while you pay down debt and save an emergency fund. In fact, that’s the best thing you can do!
  • Keep saving. After your finances are in order, start saving for a big down payment. Don’t buy a house—or sign an agreement to buy a house—when you’re broke!

We get it. Cleaning up your financial mess and saving a down payment isn’t easy. It takes hard work and sacrifice. But it’s worth it!

When you move into your new place, you’ll have peace of mind knowing you made a choice that will bless your family for years to come.

Find a Real Estate Expert

Buying a house the traditional way may take more time, but it’s worth it. When you’re ready to buy, a real estate agent can help you find a house in your budget you love.

Need help finding a top-notch real estate agent in your area? With our Endorsed Local Providers (ELP) program, we’ve done the hard work for you and vetted real estate agents around the country so you can be confident you’re working with the best.

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Ramsey Solutions

About the author

Ramsey Solutions

Ramsey Solutions has been committed to helping people regain control of their money, build wealth, grow their leadership skills, and enhance their lives through personal development since 1992. Millions of people have used our financial advice through 22 books (including 12 national bestsellers) published by Ramsey Press, as well as two syndicated radio shows and 10 podcasts, which have over 17 million weekly listeners.

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Buy a House With an Agent Who Serves, Not Sells.

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Buy a House With an Agent Who Serves, Not Sells.

You need an agent who cares more about you than their commission check.
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