Rent-To-Own Homes: What They Are and How They Work

What is rent-to-own?

A rent-to-own agreement gives you the opportunity to purchase a home after renting it for a set period. While your rent may be higher than the home’s market value, the additional amount typically goes toward your down payment when the lease ends.

With a rent-to-own arrangement, would-be homebuyers with limited savings and credit challenges can buy themselves some time to raise the necessary funds, improve their credit, and have more time to get approved for a mortgage.

A lease-to-own option may be a good idea if you need more time to save up for the purchase. But it’s important to understand its pros and cons and whether it is right for you.

In this article (Skip to...)

• How does rent-to-own work?
• Types of rent-to-own agreements
• Pros and cons
• Where to find rent-to-own homes
• Alternatives

How does rent-to-own work?

When you rent-to-own, you lease a property with the plan to purchase it at the end of the lease.

In many cases, you’ll need to pay an “option fee” or “option money” upfront to secure your right to buy the house. This fee is usually nonrefundable and paid to the seller at the start of the agreement.

If you decide not to purchase the home at the end of the lease, you generally forfeit both the option fee and any extra money you’ve contributed toward the rent.

Typically, a portion of your monthly rent is applied toward the future down payment, known as rent credit, which can be used to buy the home when the lease concludes. However, this rent credit is often limited to the last 12 months of payments and may be subject to specific requirements depending on the type of loan you pursue.

Types of rent-to-own agreements

Rent-to-own agreements come in two basic forms: lease-option and lease-purchase. Both allow you to rent a home for a one to three-year period and then buy at the end of the term.

A lease-purchase agreement is a contract between a landlord (seller) and a tenant (buyer) that merges a rental lease with a purchase agreement. In this arrangement, the tenant is legally obligated to purchase the property when the lease term ends, usually within a few years. A portion of the monthly rent is typically applied toward building equity in the home.

A lease option, by contrast, gives the tenant the option to buy the property at the end of the lease term without being obligated or required to do so. Unlike lease-purchase agreements, these contracts typically don’t apply any portion of the monthly rent toward a down payment, as the tenant may choose not to proceed with the purchase.

The pros and cons: Is rent-to-own a good idea?

As with any financial arrangement, rent-to-own homes come with both advantages and disadvantages for would-be homebuyers. It’s important to weigh the pros and cons carefully to determine whether the benefits outweigh any potential risks.

Pros

• Delayed mortgage approval. A major appeal of this type of arrangement is that if you don’t qualify for a mortgage right now, you’ll have more time to raise your credit score, as well as save for your down payment.

• Prevents competition. Another major benefit of a rent-to-own agreement is that you can avoid buyer competition. At the end of the lease term, you won’t have to compete with other buyers for the home. This can make the home buying process significantly easier and less stressful, especially in highly competitive markets.
• Ability to negotiate. Another advantage is that everything is negotiable. Unlike the typical buying or renting process, the rent-to-own market is less regulated, meaning there’s no standard contract. Key factors—such as the price and the lease duration—are entirely open to negotiation.

Cons

• Higher rent. In a rent-to-own agreement where a portion of your monthly rent is allocated toward building equity, you can expect to pay higher rent. The key word here is “portion,” as only part of your rent goes toward owning the home.
• You may overpay. The purchase price set at the beginning of this type of contract is often inflated to account for potential increases in home values. However, if you lease for several years, there’s no way to predict how the real estate market or local economy will change during that time. While the home’s value might rise, it could just as easily decline. This means you could end up paying more than the property is worth.
• Sellers are favored. In rent-to-own agreements, the seller holds most of the leverage. They profit whether they rent or sell the home, and they’re aware that many people opting for lease-to-own are in a tough financial situation. As a result, they often build multiple escape clauses into the contract. Even minor issues, like a late rent payment or not handling repairs “promptly,” could release the seller from any obligation to honor the deal.
• Loss of down payment. If the landlord’s financial situation changes and the property goes into foreclosure, ownership would transfer to the bank or mortgage lender—not to you, since the home isn’t in your name. Additionally, the seller could simply decide to back out of the agreement. In that case, you’d need to pursue costly legal action to enforce the contract, which could be an expense you’re unable or unwilling to cover.

Where to find rent-to-own homes

Rent-to-own opportunities are less common than traditional rentals or home sales, but they do exist.

A real estate agent may be able to assist you in finding available options, and some agents may even specialize in rent-to-own properties in your area. Another option is to use a rent-to-own company to find homes with owners who are specifically seeking tenant-buyers. A few of these companies include:

Home Partners of America

With Home Partners, you choose a home, and they make a cash offer to purchase it. If the offer is accepted, you sign a one-year rental lease, which can be renewed for up to five years at a fixed rent price. During this period, you have the option to buy the home at any time or just walk away when your lease ends.

Dream America

With this company, you pick any home listed for sale in available cities. Dream America will purchase that home and lease it to you for 12 months. You can cancel the lease penalty-free and buy your home at any time. There is no minimum rental period when you buy. If you aren’t ready to buy at the end of your initial lease term, if you’ve made your payments on time, you can renew for one more year.

Divvy

Divvy assists you in finding a home. If you qualify for their program, they buy the home you select and allocate a portion of your rent towards your future purchase. Their goal is to help you qualify for a mortgage within three years.

Rent to Own Labs

This company gathers rent-to-own property listings from across the country. You can search by location, and each listing provides important details about the property and its area.

Be aware of lease-purchase scams

Most rent-to-own programs are legitimate, but scammers often use these transactions to exploit unsuspecting buyers.

If your rent-to-own home has a below-market rental rate, consider it a red flag. Remember to go with your gut instinct.

In some cases, scammers will fraudulently list a property they don’t actually own, meet with the interested buyer, and pressure them into paying a cash deposit or option fee. Once the money is handed over, the scammer disappears.

Prior to providing a deposit or personal information, be sure to thoroughly research the rent-to-own arrangement.

Alternatives to rent-to-own

Before you decide on a rent-to-own due to credit challenges or not having enough for a down payment, you may want to consider other possibilities. There are lenders that specialize in working with credit-challenged mortgage borrowers.

There’s also the possibility that you’ll need less for a down payment than you expect.

For example, VA loans (backed by the Department of Veterans Affairs) and USDA loans (supported by the U.S. Department of Agriculture) require no down payment at all.

FHA loans, insured by the Federal Housing Administration, require just a 3.5% minimum down payment, while some conventional loans allow down payments as low as 3%.

And don’t forget about down payment assistance programs (DPAs). Most states and local areas offer various down payment assistance programs, grants or no-interest loans.

Rent-to-own: The bottom line

A rent-to-own agreement can help ease the process of purchasing your first home, provided the contract terms are in your favor. During the rental period, you can work on saving your down payment and improving your credit score.

While the concept seems straightforward, there can be drawbacks. If you’re considering a rent-to-own option, having a clear understanding of how they work is key to deciding if this option is right for you.