Providing a non-traditional path to homeownership, rent-to-own homes are becoming increasingly common, especially among people without enough savings for a down payment or the required credit score to obtain a mortgage. From the types of rent-to-own agreements to the risks involved, here’s everything you need to know about rent-to-own home programs.
Rent-to-own homes allow tenants to rent a house for a set period of time—usually one to three years—and purchase the house from the seller after building enough credit and securing enough money for a mortgage. This type of purchase arrangement is popular among those who want to own but do not yet qualify.
There are two types of rent-to-own, or lease-to-own, agreements: lease option and lease purchase.
In a lease-option agreement, the potential buyer pays the seller a one-time, typically non-refundable, lease-option fee (sometimes called option money or option consideration) that gives the potential buyer the option to purchase the house in the future, given they can afford it and qualify for a mortgage when that time comes. The option fee is negotiable and typically falls between 2.5% and 7% of the purchase price.
Typically with this type of rent-to-own agreement, monthly rent payments will go toward a future down payment on the home. If the tenant decides not to purchase the house at the end of the lease, the purchase option expires and the tenant loses the money they’ve invested and must vacate the property.
With lease-purchase, or obligation-to-buy, agreements, the tenant is required to buy the house at the end of the lease agreement or risk legal action to force the sale. Unfortunately, in a situation like this, if the tenant isn’t able to come up with the money to purchase the home, they could be evicted and lose all the money they’ve invested.
Most evidence seems to point to the idea that rent-to-own agreements are far more beneficial to the seller than to the buyer. As a tenant in a rent-to-own home, you probably won’t have the same rights as a homeowner: you’ll need permission to make any changes to the home, and because consumer protections are often limited in this type of agreement, you could face an eviction if the seller decides they want you out.
You could also be responsible for repairs, homeowners association fees, property taxes, and renters insurance. Additionally, if the house goes into foreclosure during the process of a rent-to-own agreement, the potential buyer could lose their entire investment.
Some agents caution against lease-purchase agreements and advise potential homeowners to consider lease-option contracts because of their non-binding nature. Other agents caution against rent-to-own agreements altogether, citing the possible risk of losing all the money you’ve invested at any point. For example, with a traditional home purchase, you wouldn’t be subject to losing your entire investment if you miss one mortgage payment, but depending on the terms of your rent-to-own agreement, you could forfeit your entire investment if you miss just one rent payment.
Another challenge with rent-to-own homes is that your monthly rent payment could be far above market value in your area. So if something goes wrong and you’re unable to purchase the home at the end of your lease, you could risk losing far more than if you had simply been a renter.
Typically, when a potential buyer signs one of these contracts, they’re locked into a purchase price and don’t have to worry about rising home prices throughout their lease, but the owner could add a clause in the contract that allows for the price of the home to increase, forcing the buyer to pay higher rent payments during the lease. If you do decide to get involved in a rent-to-own program, always read the fine print before signing an agreement and always hire a lawyer to look over all contracts and make sure these agreements work for both parties.
Also look into local regulations to see what protections your state may offer for potential buyers in rent-to-own agreements. For example, some states will allow the owner of the house to evict tenants if they fall behind on payments or are unable to come up with a down payment at the end of the agreement.
If you’re interested in this pathway to homeownership, speak with a local real estate agent who can help determine if there are any rent-to-own homes available in your area. You also may be able to find rent-to-own homes by searching sites like Zillow, Redfin, or Realtor.com.