For a lot of people, buying a house is a dream come true. But homes these days are crazy expensive, and you might be feeling discouraged because saving for a down payment or applying for a mortgage has been a challenge.
Choosing a rent-to-own home might sound like a good alternative to buying a house, but you probably have some questions. Like, What is rent-to-own? and, How does rent-to-own work? You also may be wondering about the different types of rent-to-own contracts.
To help you make a smart decision on your journey to homeownership, I’m going to walk you through exactly how rent-to-own works. We’ll also look at the pros and cons and go over some other ways to buy a home.
Let’s get into it!
- What Is Rent-to-Own?
- How Does Rent-to-Own Work?
- Types of Lease-to-Own Contracts
- Pros and Cons of Rent-to-Own
- Is Rent-to-Own Worth It?
- Alternatives to the Rent-to-Own Process
- Rent-to-own is a risky, expensive path to homeownership that you should avoid.
- Because rent-to-own homes stay in the seller’s name while you rent them, the whole deal could go south if the seller ever runs into legal trouble.
- The best way to buy a home is to keep renting while you save a down payment, then hire a real estate agent to help you buy a house the traditional way.
What Is Rent-to-Own?
A rent-to-own home (sometimes called a lease-to-own home) is a house someone rents for a limited time—usually one to three years—then buys when their lease ends.
To live in a rent-to-own home, a buyer signs a contract agreeing to the length of the lease, home price and some other factors we’ll go over in a bit. The lease contract also spells out whether the landlord has to put a certain amount of the buyer’s rent payments toward the purchase price of the home.
Lease-to-own programs are different from the typical home-buying process because they delay homeownership. So, if a buyer isn’t ready to commit to a purchase, they can live in the house as a renter in the meantime.
How Does Rent-to-Own Work?
Let’s go over the basic steps of how rent-to-own works. Even though rent-to-own is a bad idea, I want you to understand how it works so you can see how complicated the whole thing can be . . . and why you should avoid it at all costs!
Step 1: Negotiate a purchase price.
Before signing a rent-to-own contract, a buyer agrees with the seller on a purchase price. The price could be based on the home’s current value or what the seller predicts it’ll be at the end of the lease term—that’s the amount of time the buyer will rent the home before purchasing it. And since many rent-to-own agreements name the home purchase price up front, there’s a good chance you’ll wind up overpaying.
For example, if the seller thinks the house will be worth another $20,000 in five years, they’d lock in that price now, and the buyer would have to pay it . . . even if the house doesn’t go up in value. Yikes!
When the home value is predetermined like that, it’s set in stone as soon as the buyer and seller sign the contract. But in other cases, the rent-to-own agreement says the buyer and seller can set the purchase price after the lease expires.
During this step, the buyer and seller will also negotiate whether any of the buyer’s rent payments go toward the principal value of the home.
Step 2: Find out who’s responsible for repairs and upkeep.
In rent-to-own agreements, the seller may require the buyer to cover random costs like home repairs and maintenance, homeowners association (HOA) fees, and property taxes while they’re renting. That means you could find yourself on the hook for everything from landscaping fees to repairing a broken air conditioning unit if you go down the rent-to-own path. Ouch!
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That’s why it’s so important for buyers to comb through the contract with a real estate attorney who can clearly explain what each party is responsible for. Not doing so could cost them big-time.
Step 3: Agree on the term and type of lease-to-own contract.
Next, the buyer and seller will agree to a lease term in the contract—usually anywhere from one to three years. But the term could be shorter or longer depending on the situation.
They’ll also both agree to the type of rent-to-own contract—either a lease-option agreement or a lease-purchase agreement. We’ll talk more about the differences between those two contract types in a bit.
Step 4: Pay a nonrefundable, up-front fee.
Once the buyer agrees to a contract, they’re required to pay the seller a onetime, nonrefundable fee—aka the option money, option fee or option of consideration—to show the seller they’ve got skin in the game.
This locks in the buyer’s opportunity to buy the house, and sometimes the seller will put this amount toward the buyer’s down payment. Option fees are a percentage of the home’s purchase price—typically 5% or less—so you’ll need to have some cash saved before getting into a rent-to-own agreement.
Step 5: Transition from renting to buying the home.
Unless the buyer saves up enough cash to buy the house outright when their lease ends, they’ll need to get a mortgage when it’s time to buy the property.
At that point, the mortgage lender will set a closing date for when the buyer will take ownership of the property. Depending on the terms of the rent-to-own agreement, they may get credit for the rent money set aside for their purchase (and possibly the option money) as part of their down payment.
But, plot twist! If the buyer doesn’t qualify for a mortgage, the option to buy the home could expire and that might create legal issues. Not good.
Once the buyer signs the final contract, their rent-to-own home officially becomes theirs and they go from being a renter to an owner.
Types of Lease-to-Own Contracts
There are two main types of contracts when you’re getting a rent-to-own home. They both lay out the terms for renting the house during the leasing phase, but they’re different when it comes to the buying part. Let’s look at lease-option agreements versus lease-purchase agreements.
- Lease-option agreements: These contracts give buyers the option to purchase the home after the agreed-upon leasing period . . . but they don’t have to buy it. So if a buyer might want to buy the home but they’re not 100% sure yet, the lease-option contract gives them an out if they change their mind.
- Lease-purchase agreements: These contracts legally obligate the buyer to purchase the rent-to-own home after their lease ends. There’s no backing out—at least not without paying a lawyer thousands of dollars.
Pros and Cons of Rent-to-Own
Rent-to-own programs might sound like a good idea to buyers who don’t qualify for a mortgage yet but want to get their foot in the door—literally! But the downside is, rent-to-own homes come with big risks to consider. Let’s dig into some of those pros and cons.
I’m going to start with the pros of renting to own, but spoiler alert: The cons definitely outweigh the pros!
- You can avoid buyer competition. At the end of the lease term, you won’t have to compete against other buyers for the property if you have a rent-to-own agreement. And that can be a huge relief if you live in a pretty competitive market.
- Everything is negotiable. Because the process of buying rent-to-own homes is less regulated than a typical buying or renting process, there’s no standard rent-to-own contract. The terms—like price and lease term—are completely negotiable.
- You don’t have to qualify for a mortgage right away. You could be drawn to a rent-to-own program because you can’t afford to buy a home just yet. Maybe you’re still paying off debt or you don’t have a down payment saved. Those are totally valid reasons to hold off on getting a mortgage. And moving into a house without qualifying for a mortgage first might seem like the perfect solution. You can have your cake and eat it too, right? Well, this “pro” is actually a pretty big con. Here’s why: Your rent-to-own agreement is way more likely to fall through if you’re already in a financial mess. If your money situation doesn’t change drastically while you’re renting, you still won’t be able to get a mortgage when your lease ends—putting you right back at square one.
- Your rent will be more expensive. When your contract is set up so part of your rent goes toward home equity every month, your rent will be higher. And the key word here is “part,” because only part of your rent payments go toward owning the home in a rent-to-own agreement. So why not just rent a place for less money and set aside savings 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 (as I mentioned above) for the option to purchase the home down the road. But if the deal doesn’t work out, you won’t get that payment back. And you could still be on the hook for all repairs and upkeep even while renting. Unexpected emergencies can burn a serious hole in your pocket for a house that doesn’t even belong to you!
- You could pay more than the home is worth. The purchase price you lock in at the start of the rent-to-own contract is usually inflated to cover rising home values. But if you lease for a couple years, you have no way of knowing what the real estate market or local economy could do during that time. Sure, the home value could go up, but it could also drop. That means you could end up paying more than the property is actually worth. Or if you’re getting a mortgage, the bank might not lend you money on a house with a low appraisal.
- You lose money if you decide not to purchase the house. Let’s say you get a new job that you have to relocate for. Maybe you still can’t qualify for a mortgage at the end of the lease term. Or maybe 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 the cash you forked over in higher rent and option money? That’s thousands of dollars you won’t get back. (Yikes.) And if you’re in a lease-purchase agreement, you’re just plain ol’ stuck.
- Rent-to-own contracts favor the seller—not you. With rent-to-own homes, the seller has most of the power. They make money either way—either by renting out or selling the house—and they know most people who go for lease-to-own deals are in a tight spot financially. So they give themselves lots of ways out of the deal. Something as small as a late rent check or not paying for a repair in a “timely manner” could free the landlord from any obligation to honor the contract. And there won’t be a knight in shining armor headed your way to save the day—or your deal.
- You could lose the down payment you build. If the landlord’s financial situation changes and the house goes into foreclosure, the house suddenly belongs to the bank or mortgage lender—not you, because the home isn’t in your name. Or the seller could just up and change their mind. In that case, you’d have to take expensive legal action to enforce the contract. That’s a cost you might not be able (or willing) to pay.
Is Rent-to-Own Worth It?
Simply put, no—rent-to-own is not worth it. It’s often more expensive than buying a home the traditional way, and it’s dangerous because the entire deal could sink down the drain if your seller runs into any legal trouble. When you add to this big pile of red flags the fact that rent-to-own scams pop up from time to time, you have a recipe for a big mess.
Alternatives to the Rent-to-Own Process
If you’re looking into rent-to-own because you can’t afford to buy a house the traditional way right now, there’s a much better path to homeownership—working hard to get into a position where you can afford to buy a house traditionally.
How can you do that? First, pay off your debt. Getting rid of car payments, credit card bills and student loans will create extra margin in your budget that you can use to save for a house. Then, build an emergency fund of 3–6 months of your typical expenses.
Once you’ve gotten to that point, follow these three steps to prepare for buying a house:
- Make a home savings budget. Figure out how much you’ll need to save for a down payment, closing costs and moving expenses. Then decide when you want to move. Once you’ve set those savings goals, create a home savings budget to help you achieve them.
- Start saving. Don’t just make a home savings budget—stick to it! Track your spending by reviewing your transactions each month to make sure you’re staying in line with your goals.
- Hire an agent and buy your new house. Once you’ve saved your down payment and you’re ready to buy, a good real estate agent can help you find a house you’ll love that’s also in your budget. I recommend working with a RamseyTrusted agent since they’re top-performers in your local area who have been vetted by our team.
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Following all these steps may take a few years, and it definitely won’t be easy. But it’s worth it—and you can do it! Taking this path will keep you from overpaying for a rent-to-own home that could easily wind up becoming a giant curse. And trust me: You want your home to be a blessing. Rent-to-own is not the way to make that happen.
- Don’t use rent-to-own!
- Get on a budget and start saving up a strong down payment for a house.
- Connect with a RamseyTrusted agent when you’re ready to buy.
Frequently Asked Questions
What’s the difference between rent-to-own and owning?
The main difference between rent-to-own and owning a house is that rent-to-own lets buyers rent the property for a little while (typically one to three years) before buying it. It’s much more risky and often costlier than buying a home the traditional way.
How does rent-to-own work with bad credit?
Buyers with bad credit might consider a rent-to-own agreement because it lets them get into a home purchase contract even if they can’t qualify for a mortgage. Doing rent-to-own gives buyers the opportunity to build a steady payment history and pay extra rent that (if all goes well) will be set aside as a future down payment—both of which could help them eventually qualify for a mortgage.
But if you have bad credit, entering a rent-to-own agreement—where the extra rent you pay toward a down payment is out of your control and where you could be responsible for hefty maintenance costs—could put you one missed payment away from bankruptcy.