• A rent-to-own agreement is a legal contract that allows you to buy a home after renting it for a predetermined period of time (typically 1 to 3 years).
  • Rent-to-own offers allow buyers to reserve a home at a set purchase price while they save for a down payment and improve their credit. 
  • Renters are expected to pay a specified amount over the rent amount each month to apply toward the down payment. However, if the renter is unwilling or unable to complete the purchase, these funds are forfeited.  

Are you starting to feel like homeownership may be out of reach? With increasing home values across much of the country and recent changes (https://realestate.usnews.com/real-estate/articles/what-the-2-billion-realtor-lawsuit-means-for-homebuyers-and-sellers) to how buyers' real estate agents are compensated, homeownership has become less accessible— especially for first-time buyers. 

Of course, you could rent rather than buy a house, but renting doesn’t allow you to build equity. 

Rent-to-own arrangements provide a unique solution to this challenge by empowering renters to build equity during their lease term. This path to homeownership is growing in popularity due to its flexibility and equity-building potential.[1] There are, however, many misconceptions about how rent-to-own works.

In this article, we will explain how rent-to-own works in theory and practice. You’ll learn the pros and cons of rent-to-own arrangements and how to tell if rent-to-own is a good fit for you.   

What Is Rent-to-Own?

In real estate, rent-to-own is when residents rent a home, expecting to purchase the property at the end of the lease term. 

The idea is to give renters time to improve their credit and save money toward a down payment, knowing that the house is being held for them at an agreed-upon purchase price. 

How Does Rent-to-Own Work?

With rent-to-own, you, as the renter, negotiate the lease terms and the purchase option with the current property owner upfront. You then lease the home under the agreed-upon terms with the option (or obligation) to purchase the property when the lease expires.

Typically, when a renter agrees to a rent-to-own arrangement, they:

  • Establish the rental period. A rent-to-own term may be longer than the standard one-year lease. It’s common to find rent-to-own leases of two to three years. The longer the lease period, the more time you have to get financially prepared for the purchase. 
  • Negotiate the purchase price. The eventual purchase price is typically decided upfront. Because the purchase will take place a year or more into the future, the owner may expect a higher price than today’s fair market value. For example, if home prices within a specific area are trending up 3% per year, and the rental period is one year, the owner may want to set the purchase price 3% higher than today’s estimated value.  
  • Pay an upfront option fee. You pay a one-time fee to the owner in exchange for the option to purchase the property in the future. This fee is negotiable and is often a percentage of the purchase price. You might, for example, offer to pay 1% of the agreed-upon purchase price as the option fee. This fee is typically non-refundable, but the seller may be willing to apply part or all of this amount toward the eventual purchase.[2] 
  • Negotiate the rental rate, with a portion of the rate applied to the future purchase. Rent-to-own rates are typically higher than standard lease rates because they include an amount to be applied toward the future purchase. This amount is called the rent credit. For example, if the going rental rate is $1,500 per month, you might pay $1,800 per month, with the extra $300 serving as the rent credit to be applied to the down payment. It’s like a built-in down payment savings plan.   

Overview of Rent-to-Own Agreements

A rent-to-own agreement contains two parts: a lease agreement and an option to buy. The lease agreement outlines the rental period, rental rates, and responsibilities of the owner and the tenant. The option to buy outlines the agreed-upon purchase date, purchase price, and responsibilities of both parties relating to the transfer of the property.

There are two types of rent-to-own contracts:

  • Lease-option contracts. This gives you the option, but not the obligation, to purchase the property at the end of the lease term.
  • Lease-purchase contracts. This requires you to complete the purchase as outlined in the contract. 

Lease-purchase contracts could prove riskier because you may be legally obligated to buy the property, whether or not the purchase makes sense at the end of the lease term. Failure to complete the purchase, in this case, could potentially result in a lawsuit from the owner.

Because rent-to-own agreements can be constructed in different ways and have many negotiable terms, it is a good idea to have a qualified real estate attorney review the agreement before you agree to sign it. Investing a few hundred dollars in a legal consultation could provide peace of mind and potentially prevent a costly mistake. 

What Are the Benefits of Rent-to-Own Arrangements?

Rent-to-own agreements offer several benefits to prospective homebuyers.

Accessibility for First-Time Buyers

Rent-to-own homes offer first-time homebuyers a practical route to homeownership when traditional mortgages are out of reach. This approach allows you to secure a home with lower upfront costs while using the lease period to improve your credit score and build equity through rent credits.

Opportunity to Save for Down Payment 

The minimum amount needed for a down payment depends on factors like purchase price, loan type, and credit score, but many buyers need to put at least 3-5% down. With the rent credits paid during the lease term, you can automatically save for your down payment over time. 

Time to Build Credit

Mortgage lenders can typically offer better loan terms, such as lower interest rates, to applicants with higher credit scores. Rent-to-own provides time to improve your credit score to qualify for more favorable financing.

Locked Purchase Price

Locking in the purchase price can be particularly beneficial when home values rise faster than expected. For example, if a two-year rent-to-own agreement specifies a purchase price of $500,000, but the market performs well, and the value of the home is $525,000 at the time of purchase, the renter gets to buy the home for less than the market value.

Property Test-Drive

Living in the home before purchasing provides a unique opportunity to thoroughly assess the property and the neighborhood. You can make sure there are no significant issues before committing to ownership.

Possible Savings in Real Estate Fees 

Real estate agents are an excellent resource when it comes to finding homes, negotiating terms, and coordinating the transaction. If the property is already selected and terms are already negotiated, you may only need to hire an agent to facilitate the transfer. This can potentially save both buyer and seller in real estate fees.

Considerations When Entering a Rent-to-Own Agreement 

Before negotiating a rent-to-own arrangement, take the following considerations into account.

Financial Stability

Because the ultimate goal is to buy the house, it is imperative that you maintain a stable income and build strong credit to secure mortgage financing at the end of the lease term.

Contractual Responsibilities

Unlike standard rentals, rent-to-own agreements may put some or all of the maintenance responsibilities on the renter, depending on the terms of the negotiations. Renters could also be responsible for ownership expenses such as property taxes and homeowner association (HOA) fees.  

How To Exercise Your Option to Purchase

Exercising your option may have specific requirements, such as making all rental payments on time and/or notifying the owner of your intent to exercise your option in writing by a specific date. Failure to meet these terms could result in the forfeiture of your option.

The Consequences of Not Completing the Purchase

If you decide not to exercise the purchase option, the upfront options fee and monthly rent credits may be forfeited to the owner. Furthermore, if you sign a lease-purchase contract, failure to purchase the property could result in a lawsuit.

Potential Scams

Scammers may try to take advantage of the upfront fees associated with rent-to-own arrangements. For example, someone may fraudulently claim to own a rent-to-own property, accept your upfront option fee, and disappear with it.[3]  To protect yourself from rent-to-own scams, confirm the ownership of the property with public records and verify that the party offering the contract has the legal authority to do so. 

Steps to Rent-to-Own a Home

Here is a simple, five-step rent-to-own plan:

  1. Find a suitable property. Find a property you want to buy with an owner who’s willing to offer a rent-to-own arrangement. 
  2. Evaluate and negotiate the rent-to-own agreement. Review the proposed agreement with a real estate attorney who can warn you of potential risks. Negotiate terms as needed.
  3. Meet the contractual obligations. Uphold your end of the bargain to retain your rights. 
  4. Exercise your option to purchase. Follow the steps outlined in the agreement to claim your right to proceed with the purchase.
  5. Secure financing and close on your new home. Work with a lender to get a home loan, complete the purchase, and become a homeowner.  

Who Should Consider Rent-to-Own?

Rent-to-own may be a good option for potential homebuyers who:

  • Have a steady income but need time to build better credit to qualify for more favorable loan terms.
  • Are unable to afford a large down payment immediately, but can save enough during the lease term.
  • Want to test out a neighborhood or a specific home before committing to a purchase.
  • Have a concrete plan for qualifying for mortgage loan financing by the end of the lease. 

Alternatives for Potential Homebuyers

If rent-to-own does not feel like the right fit for you, consider other paths to homeownership, such as:

Final Thoughts

Rent-to-own is a legitimate path to homeownership, allowing prospective homebuyers to build equity and bolster their financial position while they test-drive a home. This can be a good option for buyers who need a little time to save enough for a down payment and/or improve their credit scores to qualify for favorable terms on a home loan.

However, rent-to-own is not ideal for every buyer. Buyers who qualify for a home loan can save the time and expense of renting to own by using traditional mortgage financing to purchase now. With multiple home mortgage loans available, you might find a lending solution that works with your current credit score and a low down payment amount.