Rent To Own? This Is How It Works

Buying a house is a major life milestone, and it’s something to carefully consider before making your final decision. Given that a down payment plus a mortgage will be a significant hit to most people’s finances, rent to own options are an attractive prospect for many would-be home buyers.

That said, the rent to own process likely has more caveats than you think, and it’s important to do your research, and do it thoroughly, before committing to a rent to own home.

In this guide, we’ll cover all you need to know.

What is a Rent to Own Home Agreement (or Rent to Own Program)?

rent to own agreement, rent to own program

For many people who want to buy a home, a rent to own option might be tempting. After all, your rent just goes toward the home price until you buy, right?

This is how many people see the process, and while they have the general idea right, there’s a lot more to it.

When you rent to own, you first pay a one-time nonrefundable option fee to the seller (this is discussed in more detail below).

Then, you and the seller negotiate to set a purchase date for the home. This is the date you’ll either be obligated to purchase the home or offered the option to purchase it, depending on your specific contract.

Usually, a sale date is no more than a few years after the start of the agreement. However, you and the seller may want to create a longer lease agreement.

Defining Rent Credit

This is where it gets a little confusing. The name, “rent to own” implies that rent payments go toward the home’s purchase price. However, that isn’t necessarily true.

On top of the regular rent the seller could charge for a tenant who was just leasing the home, each monthly payment will have a “rent credit” added.

The amount of the regular rent will go toward the seller’s current mortgage on the home, while your rent credit goes toward your down payment or total home purchase.

For example, let’s say the seller could rent a house for $1,000 per month (without a rent to own agreement). You and the seller might agree on a rent credit of $500. This way, your monthly payment is $1,500, with $1,000 going to the seller’s mortgage and $500 going toward a down payment, closing costs, or your home’s purchase price.

There’s one more key thing to know about rent to own contracts. While “rent to own” is a commonly used blanket term, it covers two different types of contracts: lease-option and lease-purchase.

Lease-Option Contracts

As the name suggests, a lease option rent to own contract simply gives you the option to buy the home at the end of the lease contract. You are in no way obligated to buy, although you’ll likely forfeit your option fee.

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Lease-Purchase Contracts

On the other hand, a lease-purchase contract is significantly more binding. These contracts require you to purchase the home at the end of the lease term. If you don’t purchase the home, you’ll forfeit the option money you paid at the start of the contract, and it’s likely you’ll face legal action, too.

Unfortunately, this requirement is usually upheld even if you can’t afford to pay, or if you can’t get approved for a mortgage.

Because these contracts can be complicated, and because unethical sellers might deliberately draw your attention away from some clauses of the contract, it’s usually wise to hire a real estate attorney to review any rent to own contract before you sign.

Do this even if you have a good feeling about the sale. A real estate lawyer can spot potential problems in the contract and they also will be able to thoroughly explain the contract to you.

While hiring an attorney will cost you money, an attorney’s fee is negligible compared to the eventual costs of getting locked into a contract you can’t afford to uphold.

How Long is a Rent to Own Contract?

The length of a rent to own contract depends entirely on your agreement with the seller. Most of these contracts last one to three years.

However, keep in mind that the goal of a rent to own contract is to give you time to get into a good enough financial place to be able to buy the home.

If you’re currently in debt or working on improving credit, you may want to take more time to build savings before getting into one of these agreements.

Alternatively, you may be able to negotiate a longer lease term. This will give you more time to save, and you’ll also have more rent credit payments to go toward your purchase.

Before you enter into a rent to own contract, it’s extremely important to choose a term that will give you enough time. Keep in mind, rental payments for these contracts are higher than monthly payments on a regular lease.

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If you don’t have enough saved to pay for the house at the end of the lease, you likely will need a mortgage. If you think you’ll just barely be able to make payments, you could potentially end the lease in a worse financial place.

The bottom line is to plan ahead and negotiate with the seller in order to choose a lease term that’s comfortable for you.

Do You Need a Down Payment for Rent to Own?

do you need a down payment for rent to own

The short answer is that you don’t need a down payment at the beginning of a rent to own contract.

However, in order to proceed with making the agreement, the seller needs some form of monetary commitment.

Option Fee

This monetary commitment is known as an option fee. It distinguishes you from a regular renter in that it gives you the option to purchase the home once your lease is done.

If you do purchase the home, this fee goes toward the home’s purchase price. If you decide not to purchase, you forfeit this fee.

If you have a lease-option contract, the fee simply gives you the option to buy the home.

If it’s a lease-purchase contract, you’ll be legally obligated to purchase the home once your lease ends.

An option fee is almost always significantly less than a down payment on a home. Generally speaking, the fee is between 3% and 5% of the home’s total value.

In contrast, down payments on homes can be anywhere from 3.5% to 20% of the total purchase price.

However, this fee is often negotiable. If a posted option fee is too high for you, it may be worth talking to the seller to see if you can re-negotiate.

However, when the lease agreement is up and you’re obligated to purchase the home, you will need to come up with a down payment. Since your option fee and rent credits can be put toward your down payment, purchase price, or closing costs, a rent to own agreement effectively helps you save for your down payment during your lease.

Rent to Own With Bad Credit

One of the draws of renting to own is that it does let those with bad credit start working towards buying a home, even if they don’t qualify for a bank-issued mortgage.

However, just as loans issued to people with bad credit often have high-interest rates due to risk, a rent to own seller may inflate fees. This is because rent to own sellers often anticipate buyers being unable to make payments.

Since losing a rent to own tenant means the seller will need to find another, charging more (whether it’s for monthly rent or for the house as a whole) helps to offset that risk.

How Much Does it Cost to Rent to Own?

As a general rule, renting to own costs more over time than buying a house with a mortgage. While we cover the costs in greater detail elsewhere in this article, it’s always wise to keep in mind all of the different costs you’ll incur:

  • Initial option fee
  • Monthly rent
  • Monthly rent credit
  • Costs for home maintenance and repairs (usually)
  • The remainder of home costs after lease (usually involves taking out a mortgage)
  • Down payment (after lease term)
  • Closing costs

Because these costs can quickly add up and become unmanageable, it’s wise to make sure you can afford them all before you commit to a rent to own contract.

Backing Out of a Rent to Own Agreement as a Seller

cancel a rent to own agreement

You already know that, depending on the type of contract you have, there may be financial and/or legal consequences if you back out of a rent to own agreement.

But is a seller able to back out?

In virtually all cases, the answer is no. Unless your contract has an explicit clause permitting it (and it would be unwise to sign a contract with a clause like this), a seller is locked into the contract until your lease is up.

This offers you significant protection. Before you sign on, you and the seller will need to choose a purchase price for the home. This locks in the price, regardless of market fluctuation.

Again, some clauses may have special stipulations covering what to do if the home’s value changes significantly, but most will settle on a purchase price.

In a rent to own contract, you have already paid for the option to purchase at the end of the lease. This means that the seller can’t cancel your contract and sell the home, even if someone with a higher offer comes along.

Of course, if you forfeit your right to purchase, the seller can then put the home back on the market.

Breaking a Rent to Own Contract

The answer to this question depends on your contract type.

For simplicity, we’ll divide this answer between the two main contract types: lease-option and lease-purchase.

Lease-Option

As mentioned above, a lease-option rent to own contract means you have the right to purchase the home after your lease has ended (and that the seller can’t sell the home out from under you during the terms of your lease).

In this situation, you have the ability to back out. One unique facet of rent to own contracts is that, when there’s no contractual obligation to purchase, you don’t need to continue renting through the end of the lease.

However, if you do this, you forfeit your option fee as well as all rent credits you’ve accumulated. Since this option results in a significant loss of money for you as a buyer, it’s usually unwise to do this unless you have a truly compelling reason.

Lease-Purchase

The binding nature of a lease-purchase contract means that you can’t back out of your agreement.

Even if you can’t afford to pay the remainder of the home’s purchase price at the end of the lease, you’ll be legally obligated to. If you refuse, or attempt to otherwise back out of the agreement, the seller can sue you for the remainder of money owed.

Barring any extreme and extenuating circumstances, the seller will win the lawsuit and you’ll be court-ordered to pay. Thus, unless you are absolutely certain you’ll be able to buy the house at the end of the lease, a lease-purchase agreement is risky.

Can You Evict a Rent to Own Tenant?

A common misconception about rent to own agreements is that you can’t be evicted while you’re a tenant. Unfortunately, the truth is that the seller does have the option to evict you. Usually, eviction can only happen if you fail to make the monthly payments.

However, before proceeding with eviction, the seller legally needs to give you a three-day notice to pay the rent you owe. If you fail to pay in that time window, the seller may then legally proceed to evict you.

Exact eviction regulations and procedures vary widely by state, so check with your local jurisdiction to see how local eviction proceedings are carried out.

If you find yourself risking eviction, it’s often worthwhile to reach out to your seller and try to work out a compromise. Remember that eviction will also cost the seller money and time.

And of course, if you are evicted, the seller will then be faced with finding another rent to own tenant. If you’re successfully evicted, your option fee (and likely your rent credits) will not be returned.

Thus, it’s usually in the best interest of both you and the seller to come to a mutually agreeable solution.

Property Taxes on Rent to Own Homes

While we’ve already covered how paying for the seller’s mortgage, the down payment, the remainder of the home price, and the closing costs works, there’s another key consideration to be aware of.

Who pays the property tax?

After all, a home in a rent to own contract is in a sort of ownership limbo; there’s a possibility you as the tenant will ultimately purchase it, but there’s a chance that ownership will remain with the seller.

However, since the seller is still the official property owner during your rent to own lease, he or she is responsible for paying property taxes.

Remember that your option simply gives you the option of purchasing the home. From the seller’s point of view, the sale of the home isn’t completely guaranteed.

Also, if the home is in a neighborhood with a Home Owner’s Association (HOA), the seller is responsible for these fees until the conclusion of the lease as well.

Once the sale is complete and ownership is legally transferred, you will be the legal owner and thus responsible for all property taxes and any HOA fees that apply.

Are Rent to Own Homes More Expensive?

rent to own more expensive

If you’ve ever applied for credit cards or loans with a low credit score, you know that many services aimed at those with lower income end up being more expensive in the long term.

Since it’s often difficult for lower-income people to buy a house right away with a down payment and mortgage, you may be wondering if the overall price of rent to own homes is more expensive.

Somewhat predictably, renting to own is generally more expensive than buying a home in the traditional way.

However, if homeownership is important to you and you can’t qualify for a mortgage, renting to own is less expensive in the long run than renting with no option to purchase. Plus, even if you qualify for a mortgage with a less than excellent credit score, it’s possible that the interest rate you receive will cause you to pay more in the long run.

Perhaps worst of all, if you enter into a rent to own contract and then back out, the contrast will cost you both the rent credits paid toward your home each month and the option fee you paid at the beginning of the contract.

This loss of savings can sometimes take a significant amount of time to build back up.

When Renting to Own a House, Who is Responsible for the Repairs?

You already know that a rent to own agreement differs from your typical lease. In a traditional renting arrangement, the landlord covers all repairs through the duration of your lease term.

In most cases, you as the tenant (and future owner) need to cover all repairs the home needs, even before you complete the official sale on the agreed-upon future closing date.

Depending on the condition of the home at the beginning of your contract, this clause has the potential to cost you a significant amount of money. It’s often wise to have the home inspected before signing a rent to own contract, as a knowledgeable inspector can identify any existing issues that may lead to an expensive repair down the lines.

If you aren’t sure where to find a reputable inspector, try asking a local real estate agent; many can recommend dependable contractors who can conduct a thorough home inspection.

Of course, some contracts stipulate that the seller needs to cover all repairs. But even in these cases, you’ll likely be responsible for all home maintenance. This includes mowing the lawn, cleaning the gutters, and other routine tasks.

If you haven’t owned a home before, performing these tasks will help you get used to what owning a home entails.

The Advantages of Rent to Own

Renting to own is not without risks. However, it does offer many potential advantages for tenants who enter a contract.

It Helps Those With Poor Credit Achieve Home Ownership

For many people with poor credit (and even those whose credit is good but not excellent), buying a home with a mortgage and down payment is out of reach.

If your credit isn’t great, these contracts give you a chance to build credit history through paying rent each month. As you do this and build equity in the property, your credit score will improve, and it also gives you more time to save money towards the total cost of the home.

Then, if you need to take out a mortgage to cover the remainder of the purchase price, your credit score will be higher and your approval odds will increase.

It Can Protect You Against Market Fluctuations

By the time your lease is up and you have the option to purchase, the fair market value of the home may have gone up. However, in the vast majority of rent to own contracts, the buyer and seller reach an agreed-upon final sale price for the home.

This way, if the home’s current market value at the time of closing is higher, you’ll be getting an excellent deal on the property. That said, be sure you fully understand your contract at the time of signing.

Some agreements include clauses that allow for fluctuation of the home price based on real estate market value at the time your lease is up.

It Lets You Get a Feel for the Property

If you’re like many renters, you may have signed a lease on an apartment for a year, only to find that there’s something you hate about it.

Maybe it’s too far away from restaurants and concert venues. Or maybe it feels too cramped to be a comfortable living space. Regardless, you know you’ll be let out of your lease within a year.

However, if you buy a home and feel the same way, it’s a lot more complicated than just waiting for a lease to expire. You’ll need to sell the house before moving, and if the sale takes awhile, you’ll be stuck in the meantime.

When you rent to own, you essentially have a trial of the property before committing. You’ll be able to see if you feel at home in the space, as well as explore surroundings and see if you live in a community where you would feel comfortable staying.

While it’s true that you’ll forfeit your option fee and rent credits if you choose to leave, this is often better than going through the challenges of selling a home.

Why a Seller Would Rent to Own

Now you know the potential benefits you stand to gain by entering into a rent to own contract. However, sellers don’t usually operate on altruism alone. Rent to own contracts have some benefits for the seller, too.

Additional Income Opportunities

Many sellers are interested in saving up money, too. Since your base rent payments go to the seller, this enables them to put money away before finally selling their home. This is also helpful to sellers who may have already purchased a new home and are juggling two mortgages.

Since your rent goes toward any existing mortgage on the home you’re renting to own, this enables the seller to have a little more financial security.

Reaching a Variety of Potential Buyers

As we mentioned above, many people with subpar credit end up unable to qualify for mortgages from banks. Since selling a home is challenging in many areas, offering a home as a rent to own purchase means the seller has more potential buyers who are willing and able to purchase the home.

Higher Sales Prices

In some cases, a seller stands to earn more money by selling a home as a rent to own purchase. Given that buyers have more time to save money as they rent, they may be more willing to purchase a home with a higher total cost.

Plus, while it’s inconvenient to have a buyer exit a rent to own agreement, the seller still gets to keep the option fee and any rent credits.

When your lease expires based on the closing date you and the seller agreed upon at the beginning of the contract, the seller knows they’ll either receive the rest of the home’s purchase price or get to keep the money you’ve already invested.

Do Banks Do Rent to Own Homes?

The short answer here is no. Rent to own contracts are generally complex, and part of their appeal is that they allow the seller to pay the mortgage and other costs more comfortably.

Since banks make plenty of money already through offering mortgages (which are also usually simpler contracts), it makes little sense for them to become involved in rent to own sales.

However, if you’re very interested in a foreclosed property now owned by a bank, you don’t need to give up hope just yet. If you’re motivated and willing to get creative when it comes to financing, getting in touch with an investor is one way to achieve a rent to own agreement on a foreclosed home of your dreams.

Some investors may be able to buy the home outright and then draw up a rent to own contract with you. Be mindful that an investment is designed to make money, and your rates with an investor may be higher than they would be with an existing homeowner who’s just trying to sell.

The HOPE Program

If you’re a disadvantaged or otherwise low-income person looking to buy a home, it’s important to know that there are alternatives to rent to own programs that still offer some degree of support.

One of these is the HOPE program.

HOPE stands for “Homeownership and Opportunities for People Everywhere,” and it’s designed to help those who are lower-income, have poor credit, or otherwise face challenges when looking to purchase a home.

This program was launched by the Department of Housing and Urban Development.

However, the HOPE program doesn’t directly offer assistance to individuals. State or regional authorities apply for HOPE grants directly.

These grants are commonly used to help individuals in a given area with down payments or mortgage payments. They also can be used for education programs for would-be homeowners.

If you’re considering purchasing a home through a rent to own program, it may be worthwhile to explore whether the area where you want to buy a home has a HOPE program. Even if they don’t, you may have other options.

Many areas, especially those that are being revitalized, have programs to incentivize homebuyers. Many of these programs include courses to help prepare you for owning a home, and they may offer assistance with your purchase.

However, some of these programs require you to continue living in the home for a decade or more. If you aren’t intending to move soon after your purchase, these programs offer great cost savings.

But if you’re someone who moves frequently, this may not be the right choice for you.

Is It a Good Idea to Do Rent to Own?

The answer to this question is a complex one. As we’ve seen, renting to own offers several advantages. It allows you more time to save for a down payment and other home costs, it opens up the possibility of homeownership if you don’t qualify for a mortgage, and it lets you spend some time actually living in a home before committing to ownership (unless you have a lease-purchase contract).

However, renting to own carries several risks for buyers, including potential eviction if you can’t make payments. Even though having a set purchase price protects you if the home’s value goes up, it can be disappointing if the home’s market value depreciates significantly during your lease term.

Thus, while renting to own may be a great choice for some, it ends up being a bad idea for many.

High Monthly Payments

Part of the idea of these programs is to allow you to save money. But when you’re low-income or credit-challenged, paying the additional rent credit on top of your monthly lease payment is often the last thing you need.

And if your employment situation is unstable, this adds even more risk.

If you lose your job and find yourself unable to make monthly payments, you risk losing the hard-earned money you’ve already put towards rent credits and option fees.

Since this money goes towards a final home purchase, the seller keeps it in many circumstances and this will set you back when it comes time to purchase another home down the line.

Even worse, if you’re evicted, this can make it very difficult to rent or sign a rent to own contract in the future.

Potential Problems With Final Purchases

Many potential homeowners sign rent to own agreements fully believing that when it comes time to buy, they’ll have improved credit scores and enough savings to easily qualify for a mortgage.

Sadly, this is not always the case.

If you incur medical or other debt during your lease term, you may still be unable to qualify for a mortgage. At this point, your best case scenario is forfeiting rent credits paid toward the home every month.

It also involves forfeiting option fees and walking away empty-handed (and needing a new place to live).

At worst, you’ll face these consequences plus potential legal action from the seller, and you may be court-ordered to pay for the rest of the home, too. While you can walk away from many of these contracts, exiting one always has a financial consequence.

Wrapping It All Up

If you’re determined to rent a home to own, this isn’t to say it’s something you should never do. However, before signing a contract, it’s wise to talk to a financial advisor.

He or she will likely have seen both the success stories and the catastrophic failures of the rent to own market.

An adviser with experience in this area will be able to assess your situation and offer you an honest opinion on whether a rent to own endeavor suits your needs.

Additionally, because current mortgage rates are constantly changing, an advisor may even advise you to wait two or three years, build up your credit history and employment history, and then apply for a more traditional mortgage.

If you decide renting to own isn’t for you, remember your other options. The HOPE program and other programs are designed to help people who are looking for a home but need financial assistance.

Many of these programs have more affordable rates and more transparent terms. You’ll also be working with a standardized program and not with a seller who may prioritize his or her needs to your detriment.

If you’re interested in buying a home but need help exploring options, you also may want to consult with a top real estate agent or other knowledgeable professional in your area. Even if an agent works for a private company, they’re likely to know about the real estate market as a whole.

At the very least, they can help point you in the right direction.

The home buying process is both a commitment and an adventure. Remember that renting to own and going through a traditional bank-issued mortgage are not the only ways to go.

When you take your time, do your research, and keep options open, you’ll be more likely to find a home buying option that suits your needs.

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About The Author

Ryan Luke is a father of three, a husband, finance blogger, and a full-time police officer. Through proper budgeting and money management, they have been able to live off one income and build wealth at the same time. As an active member of the personal finance community, his goal is to educate and help people get out of debt and build wealth!

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