Rent-to-Own Homes: How the Process Works

If you’re like most home buyers, you’ll need a mortgage to finance the purchase of a new house. To qualify, you must have a good credit score and cash for a down payment. Without these, the traditional route to homeownership may not be an option.

There is an alternative, however: a rent-to-own agreement, in which you rent a home for a certain amount of time, with the option to buy it before the lease expires. Rent-to-own agreements consist of two parts: a standard lease agreement and an option to buy.1 Here’s a rundown of what to watch for and how the rent-to-own process works. It's more complicated than renting, and you'll need to take extra precautions to protect your interests. Doing so will help you figure out whether the deal is a good choice if you're looking to buy a home.

KEY TAKEAWAYS

A rent-to-own agreement is a deal in which you commit to renting a property for a specific period of time, with the option of buying it before the lease runs out.

Rent-to-own agreements include a standard lease agreement and also an option to buy the property at a later time.

Understand that lease-option contracts give you the right to buy the home when the lease expires, while lease-purchase contracts require you to buy it.

You pay rent throughout the lease, and in some cases, a percentage of the payment is applied to the purchase price.

With some rent-to-own contracts, you may have to maintain the property and pay for repairs.

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Rent-To-Own Homes: How The Process Works

Nonrefundable Upfront Fees

In a rent-to-own agreement, you (as the buyer) pay the seller a one-time, usually nonrefundable, upfront fee called the option fee, option money, or option consideration. This fee is what gives you the option to buy the house by some date in the future. The option fee is often negotiable, as there’s no standard rate. Still, the fee typically ranges between 2.5% and 7% of the purchase price.

Lease-Option vs. Lease-Purchase

It’s important to note that there are different types of rent-to-own contracts, with some being more consumer friendly and flexible than others. Lease-option contracts give you the right, but not the obligation, to buy the home when the lease expires. If you decide not to buy the property at the end of the lease, the option simply expires, and you can walk away without any obligation to continue paying rent or to buy.

Watch out for lease-purchase contracts. With these, you could be legally obligated to buy the home at the end of the lease, whether you can afford to or not.2 To have the option to buy without the obligation, it needs to be a lease-option contract. Because legalese can be challenging to decipher, it’s always a good idea to review the contract with a qualified real estate attorney before signing anything, so you know your rights and exactly what you’re getting into.

Agreeing on the Purchase Price

Rent-to-own agreements should specify when and how the home’s purchase price is determined. In some cases, you and the seller will agree on a purchase price when the contract is signed, often at a higher price than the current market value. In other situations, the price is determined when the lease expires, based on the property's then-current market value. Many buyers prefer to “lock in” the purchase price, especially in markets where home prices are trending up.

Applying Rent to the Principal

You’ll pay rent throughout the lease term. The question is whether a portion of each payment is applied to the eventual purchase price. As an example, if you pay $1,200 in rent each month for three years, and 25% of that is credited toward the purchase, you’ll earn a $10,800 rent credit ($1,200 x 0.25 = $300; $300 x 36 months = $10,800). Typically, the rent is slightly higher than the going rate for the area to make up for the rent credit you receive. But be sure you know what you're getting for paying that premium.

In some contracts, all or some of the option money you must pay can be applied to the eventual purchase price at closing.

Rent-to-Own Home Maintenance

Depending on the terms of the contract, you may be responsible for maintaining the property and paying for repairs. Usually, this is the landlord's responsibility, so read the fine print of your contract carefully. Because sellers are ultimately responsible for any homeowner association fees, taxes, and insurance (it’s still their house, after all), they typically choose to cover these costs. Either way, you’ll need a renter’s insurance policy to cover losses to personal property and provide liability coverage if someone is injured while in the home or if you accidentally injure someone.3

Be sure that maintenance and repair requirements are clearly stated in the contract (ask your attorney to explain your responsibilities). Maintaining the property, e.g., mowing the lawn, raking the leaves, and cleaning out the gutters, etc., is very different from replacing a damaged roof or bringing the electric up to code.