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If you’ve heard the phrase “rent-to-own,” you might be wondering to yourself, “How does rent to own work?” Rent-to-own homes start very similarly to a typical rent agreement. The main difference is that the contract allows the renter to buy the house at a certain point in the future. This may sound like an ideal solution, so why don’t more people do it? Well, it—of course—comes with some downsides. Keep reading to find out what rent to own is, how it works and if it’s right for you.
Rent-to-own means that you pay rent on an asset, such as a piece of property or a vehicle, with the opportunity to buy the asset out one day. A portion of the payments you make while renting can contribute to the final purchase price.
Most people today are more familiar with a rent-to-own model when it comes to cars. When you lease a vehicle, you can typically opt to buy the car at the end of the agreement for the remaining balance.
Rent-to-own is relatively straightforward, but it’s crucial to understand the details before deciding if it’s right for you. First, it’s important to know that a contract for a rent-to-own home typically sets the home’s price at a higher value than the current market value. This is because the assumption is that the market will go up over the life of the contract.
There are two types of rent-to-own agreements: a lease-option agreement and a lease-purchase agreement. In the lease-option version, you have the option to buy the house at a specific date for a particular amount. If you don’t want to buy when the time comes, you simply pass up the opportunity.
For example, let’s say you agreed on a rent-to-own home contract where you would buy the house in 10 years for $200,000. Unfortunately, the contract ends during a recession and the housing market has seen a dip. The current value of the home is only $150,000. In a lease-option agreement, you might opt to walk away from the home purchase as it’s not worth $200,000.
On the other hand, a lease-purchase agreement is definitive. You’re expected to buy the home when a specific date comes. So, in the above example, a lease-purchase deal means you’d be expected to buy that home at $200,000 even though the current market value is $150,000.
It’s essential to understand which type of agreement you have so you can prepare yourself. Generally speaking, a lease-purchase agreement is less ideal because you have fewer options.
A rent-to-own contract comes with an option fee, also known as option money or option consideration. To give you the option to buy the home one day, the lender collects a fee of between 1 and 5 percent of the home’s price. This fee is negotiable, but it’s paid up front and is nonrefundable. If you decide to buy the house in the future, this option fee is sometimes applied to the home’s price.
Make sure to understand your option fee before signing a contract. You’ll want to negotiate the amount, ask for it to apply to the future home price and get everything in writing.
As mentioned, the home’s purchase price is typically set above the home’s current market value. The renter and the landlord decide on a purchase price together. You should only agree to a price that makes sense. It’s essential to research how much homes in the area are currently worth, previous home sale trends and expected housing market trends.
In most cases, the purchase price is set when the two parties sign a contract. It’s possible to set up a rent-to-own home contract without defining a purchase price. This comes with both positives and negatives.
On the one hand, it’s harder to plan for your purchase price because you don’t know what it’ll be. If the housing market spikes during your rental contract term, you might not be able to afford the suggested price. On the other hand, by not agreeing to a price, you can probably get the house at a fair market price.
Additionally, the renter and landlord agree to the rental term length. Typically, landlords only like to sign rent-to-own contracts for between three and five years. A renter should agree to a term length that will allow them to get their finances in order, be approved for a mortgage and save to buy.
In some rent-to-own contracts, a portion of the rent payment can apply to the future purchase price. For example, let’s say you pay $1,000 in rent monthly and 15 percent is applied to your future home sale. Over a contract of three years, you’ll get a credit of $5,400 toward your price.
Note that if you get this type of contract, your rent will likely be placed slightly higher than market rates. Once again, this is to make things fair for the landlord so they aren’t losing out on their profits.
You should get all these details in writing to ensure you have proof when it comes time for the home sale.
A rent-to-own home makes the maintenance obligations less clear. In a typical renter-landlord relationship, the landlord is obligated to deal with home maintenance issues. However, in a rent-to-own situation:
The contract should spell out who will be responsible for home maintenance and the costs associated with it. Additionally, it should spell out if this applies to minor care (landscaping) or major maintenance (furnace breaking).
Additionally, the contract may have other rules, such as whether pets are allowed.
When a rent-to-own home contract is almost up, the renter should prepare themselves for the buying process. This process will be similar to buying a traditional home, and the renter will need to be approved for a contract. So, they’ll need good credit and need enough to cover the purchase price.
However, one benefit is that rent-to-own homes can come with slightly reduced costs because of previous rental payments made.
A rent-to-own home contract may be a good fit for:
For more information on rent-to-own, examples of contracts, red flags to look out for and ways to shop for the best deal, download the Complete Rent-to-Own Guide for Prospective Homebuyers.
Normally with home buying, a real estate agent helps you negotiate to make sure you get fair market value on everything. You don’t have that with rent-to-own, so you need to be your own advocate.
You likely shouldn’t take the first offer on anything in a rent-to-own home contract. For the contract, the option fee, the maintenance roles, the lease terms and more, remember to negotiate. This can save you a lot of money in the long run.
There are a lot of scams with rent-to-own contracts. Some of the most common ones are:
Before committing to a rent-to-own contract, it’s important to research everything. Look into the contract terms, the seller, the house and the fine print. Does the landlord actually own the home? Are they in financial trouble? Is the final home amount priced fairly? Is the monthly rental fair? Can they provide you with a recent home inspection? Ask these questions and verify the answers.
Purchasing a home is one of the biggest decisions in your life. Typically, you have a real estate agent to walk you through it. While Realtors aren’t typically involved in rent-to-own contracts, it’s still essential to seek professional help. Find a real estate agent or lawyer to review your agreement. They may find red flags that you missed.
Rent-to-own can be an excellent option for some people, such as those focusing on improving their credit in the next few years. Still, it comes with some risks. Individuals should understand that they’re paying—in a few ways—for the option of rent-to-own. Always do your research and be fully informed before committing to a rent-to-own contract.
If you’re considering purchasing a home soon, it’s important to make sure your credit is as healthy as it can be. You can find out what kind of credit score you need to purchase a home here. And remember, Lexington Law Firm’s professionals are here to help individuals evaluate their credit score and identify areas for improvement.
Reviewed by Miriam Allred, an Associate Attorney at Lexington Law Firm.
Miriam Allred was born and raised in Southern California. After high school she joined the US Navy. She then went on to get an Economics degree from Chapman University where she got to enjoy an internship at the United States Supreme Court. Miriam then went to Brigham Young University where she received her Juris Doctor. Prior to joining Lexington Law, Miriam worked as a civil rights attorney dealing with discrimination and sexual harassment. In this role she helped write and create policies and investigate sexual harassment and discrimination complaints. Miriam also has experience in family law. Miriam is licensed to practice in Utah.
Note: Articles have only been reviewed by the indicated attorney, not written by them. The information provided on this website does not, and is not intended to, act as legal, financial or credit advice; instead, it is for general informational purposes only. Use of, and access to, this website or any of the links or resources contained within the site do not create an attorney-client or fiduciary relationship between the reader, user, or browser and website owner, authors, reviewers, contributors, contributing firms, or their respective agents or employers.
Lexington Law is not an RTO company. Any content provided on this website regarding the topic of RTO is nothing more than a resource Lexington Law believes might be helpful to readers of its website. Lexington did not write this content. It was provided by a third party. The information provided on this website does not, and is not intended to, act as legal, financial or credit advice; instead, it is for general informational purposes only. Use of, and access to, this website or any of the links or resources contained within the site do not create an attorney-client or fiduciary relationship between the reader, user, or browser and website owner, authors, reviewers, contributors, contributing firms, or their respective agents or employers. Lexington did not write this content. It was provided by a third party.
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