Rent-to-Own Homes: How It Makes Homeownership More Attainable

It’s no secret that it’s getting harder to buy a home. That’s why many would-be homeowners are looking at rent-to-own homes as an alternative to the traditional path to homeownership—especially if they’re first-time home buyers.

It’s a less straightforward way than most people traditionally take to get their dream homes, and you have to know exactly what you’re getting into before you sign a rent-to-own contract.

So we asked real estate expert Alex Ludwinek, co-owner of Houston-based Realty ONE Group Optima, and Tom McCormack, senior partner and broker at Resources Real Estate in New Jersey, for their advice to people thinking of going the rent-to-own route to a new home.

What is a rent-to-own home?

A rent-to-own arrangement is where you rent a home from a property owner, except with a twist in which part of your monthly rent payments also go toward helping you meet the home’s purchase price. That means that simply paying your landlord every month is also part of the home-buying process.

“Rent-to-own allows potential homebuyers the ability to rent a home for a set period of time before buying it,” Ludwinek says. “The buyer pays a downpayment, called an option fee, which is a percentage of the purchase price.”

Though the specifics of each contract can vary, Ludwinek outlined a fairly typical rent-to-own agreement’s basic parameters.

“The buyer will pay monthly rent payments that include a credit towards the downpayment,” Ludwinek says. “To clarify this, let’s say you want to buy a $200,000 home via a rent-to-own agreement. Assuming a 5% option fee, you will pay a downpayment of $10,000. In this example, the monthly rent is $1,500 paid to the landlord and an additional $250 that the buyer pays towards their downpayment. If the buyer rents for 24 months, they will have accumulated a total of $16,000 in downpayment that they can use towards the purchase of the home.”

Pros and cons of a rent-to-own home

There are pretty big reasons to consider a rent-to-own arrangement, under the right circumstances. For one, your monthly rent payments aren’t just going to line your landlord’s pockets, they’re also working for you to build equity.

And you don’t have to wait to move in once you’ve found the new home for you—you can move in as a tenant and potentially work out a home loan and the other, often time-consuming, aspects of buying a home once you’ve decided to exercise the buying option on your rental agreement.

Plus, unlike when you’re the outright owner of the property, you’re not on the hook for certain expenses, such as property taxes.

“The landlord owns the property until closing, so they are responsible for property taxes and other expenses unless explicitly negotiated otherwise and incorporated into the lease agreement,” McCormack says.

Importantly, rent-to-own arrangements usually fix the home’s purchase price at the time of the signing of the contract. So if the real estate market shifts and the rent-to-own property becomes more valuable, the buyer could end up getting a great deal on their new home.

There are downsides, too, of course.

The most obvious is that it takes a longer amount of time to become the official owner of a rent-to-own home, unlike with the more usual mortgage arrangement, where you’re still considered the legal owner of a home even if a bank helped you buy it. That means that the usual terms and conditions of a standard rental agreement can apply.

“Even in a rent-to-own situation, the landlord retains full rights as a landlord and, as such, may evict a tenant for nonpayment according to local ordinances,” McCormack says.

If the housing market goes the other way than you hoped and the market value of the rent-own-property actually drops, you’d still be responsible for buying the home at the negotiated price, which could be a much worse deal than at the start of the lease term.

“As the purchase price is pre-negotiated, you might end up paying more than the house’s worth if its value decreases during the rental period,” Ludwinek says. “The purchase price of the home is locked in at the start of the agreement. The buyer will benefit if the home appreciates in value, however, if the home depreciates the buyer will still be required to pay the originally negotiated price.”

And the time it takes for your rent-to-own contract to play out also means you could be vulnerable to financial fluctuations that ultimately make buying the home impossible for you.

“Interest rates will have an effect when you go to obtain financing for purchasing the property at the end of the lease,” Ludwinek says. “You may find that interest rates went up significantly from when you entered the agreement and you may no longer be able to qualify for financing at the higher rates. This may result in you having to walk away from the home, losing your downpayment.”

And though the landlord’s technically the person in charge of paying property taxes and, in most contracts, maintenance and repair, as a buyer, you’ll often find yourself taking the lead on keeping the place up, for all practical purposes.

“As the buyer is vested as a soon-to-be owner, they will inherit any issues that arise with the home, and it is in their best interest to have it repaired to their liking,” Ludwinek points out.

And, finally, among the most potentially jarring cons of a rent-to-own program is that you’re not just at the mercy of your own financial circumstances, you’ll feel the fallout of your landlord’s, too.

If your landlord loses the home to foreclosure, for example, you’re suddenly going to be dealing with a whole new owner who doesn’t necessarily have to abide by the terms of an rent-to-own agreement he or she didn’t sign up for.

Different types of rent-to-own contracts

Rent-to-own agreements can vary a lot, from the amount of the option fee, the terms of the end of the lease and lease option, who pays the closing costs and property taxes, and so on. There are a lot of unforeseen circumstances you want to protect yourself against, so you’re definitely going to want to hire a real estate attorney who’s familiar with rent-to-own contracts.

“An attorney is very advisable in a rent-to-own situation to ensure the tenant/buyer is protected, especially as it might relate to monies to be attributed to the downpayment,” McCormack says.

The most important thing to know about the different types of rent-to-own agreements is that they come in two critically different flavors: lease-purchase agreements and lease-option agreements.

“The fundamental difference between the two is that in a lease-purchase you are contractually obligated to purchase the property at the end of the lease, whereas in a lease-option you can decide to walk away from the home at the end of the lease,” Ludwinek says.

Both types of rent-to-own agreements, however, work the same when it comes to how much you’re paying month to month.

“In a rent-to-own agreement, you pay a little extra to help yourself save for a downpayment,” Ludwinek says. “This happens in two ways: rent credits (paid monthly) and an option fee (paid once, up front). The option fee is typically 1 to 7% of the purchase price.”

Also in either case, you can usually switch from a vanilla rental agreement to a rent-to-own agreement, if the owner’s willing. Just keep in mind that you can’t claim retroactively to already be partway to the home purchase because of the monthly rent payments you’ve already made.

“You would just need to sign a new rent-to-own agreement and pay the downpayment and increased rent,” Ludwinek says. “As you were in a standard lease prior to converting to rent-to-own, you would not receive a credit for any rent paid, as the extra downpayment credit was not being collected.”

If, on the other hand, you are already in a rent-to-own agreement and want to switch to a standard rental agreement instead, you can probably do that—but you’ll also usually lose all the downpayment you’ve already paid, since you’re breaking the contract. The same goes for if it turns out you still can’t afford to buy the property at the end of the lease.

“[T]he option simply expires, and the renter can walk away without any obligation to continue paying rent or to buy but will lose any downpayment paid,” Ludwinek says.

Note that if you try to walk away from a lease-purchase agreement, you may be leaving yourself open to a civil suit from the landlord for part of all of the lost home sale. This is definitely something you should talk about with a real estate attorney who knows the rent-to-own laws in your state.

Other specifics of a rent-to-own agreement, including what happens if the owner loses control of the property (like by selling it or having it foreclosed on) or whether you, as the renter, can speed up the process with a mortgage loan or increased payments, can depend on the terms of the agreement and are points you and your real estate attorney should discuss.

Who is a rent-to-own home good for?

A rent-to-own home is typically best for those who are in a relatively cash-poor financial situation but who want to move into a new home in a shorter period of time, such as when they can’t afford to make the downpayment up front.

“A rent-to-own situation benefits a renter who may otherwise be unable to come up with the funds for a downpayment,” McCormack says.

But it’s also the kind of agreement that can benefit certain property owners, like those wary of a fickle real estate market.

“A homeowner who is having trouble selling a property may also benefit, as will a homeowner who may want to lock in a buyer at today's prices (thinking the value may go down with time), especially if they have reasons for wanting to delay the sale,” McCormack says.

Who qualifies for a rent-to-own home?

Anyone who qualifies to buy a home theoretically qualifies for a rent-to-own home. But the rent-to-own market encompasses a broader base of people, including those who can’t buy a home right off the bat but who may be able to eventually. That might include people with bad credit scores who can’t get a home loan now but are making efforts to improve their credit scores to apply for home loan down the line.

How to find rent-to-own homes

Real estate markets vary so widely from place to place, neighborhood to neighborhood, city to city and state to state, that it’s close to impossible to delineate a practical general method to finding potential rent-to-own homes for your particular situation. As always, it’s advisable to speak to an experienced real estate agent who intimately knows the real estate market you want to buy in.

FAQs

A mortgage lender, typically a bank, loans you the money you need to buy a home outright. You repay the mortgage lender with monthly mortgage payments. If you can’t make your mortgage payments, the lender can take possession of the home, but until then, you’re the legal owner of the home.

Under a rent-to-own agreement, you make a downpayment and monthly payments toward the home purchase price on top of your monthly rent payments. At the end of the rent-to-own contract, you can purchase the home less the payments you’ve made toward buying the rent-to-own property. You are not the legal owner of the home, in most cases, until the end of the lease and only if you exercise the option to buy.

Credit bureaus, the agencies that analyze your credit history and assign you a credit score, use weighted factors to come up with what’s used to judge your reliability in paying back loans: payment history (35% of your score), debts owed (30%), length of credit history (15%), new credit applied for (10%), and type and variety of credit (10%). As long as you pay your landlord on time every month—whether that’s a standard rental agreement payment or a rent-to-own payment—it shouldn’t have any harmful bearing on your credit score.

Every state allows rent-to-own agreements, but the specifics vary from state to state, and some states regulate rent-to-own properties much more stringently than others. You should always consult with a real estate lawyer familiar with the laws of the state you want to buy in before committing yourself to a rent-to-own contract.