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The real estate market can be intimidating for anyone, especially those who may be in the market for their first home or who may have less-than-excellent credit. In 2023, the average median down payment on a home in the United States was slightly over $34,000. For many young people, the idea of saving up that much can feel impossible.
Luckily, there’s another option. Rent-to-own homes can be an excellent way for those who need more time to be ready for homeownership. But if rent-to-own is so great, why isn’t everyone doing it? Well, rent-to-own does come with some significant downsides. Keep reading for a comprehensive overview of rent-to-own vs. buying to understand which option is right for you.
What does rent-to-own mean?
The process of rent-to-own is very much what the name sounds like. You start by renting the home but enter into a contract as part of your rental agreement that you intend to purchase the house after an agreed-upon time (usually one to three years).
As long as you buy the home, a specific portion of your rental payments, determined up front, is applied to the price of the house.
A rent-to-own agreement also locks in the price of the home at the time of the contract, so you don’t have to worry about appreciating values putting the house out of your financial reach after a few years.
For example, you can sign a contract saying 25 percent of your rental payments will go toward the home purchase after five years of renting. The agreement values the home at $350,000, which is what you’ll buy it for at the end of the five years. Your rent is $2,000 a month, so you’ll have a “down payment” of $30,000 at the end of the five years.
When you choose rent-to-own, you have to decide if you’ll go with a lease-option or a lease-purchase agreement. A lease option means you can buy the home at the end of the rental period, but you aren’t legally bound to do so. This option gives you some flexibility.
A lease-purchase is a legally binding agreement that you’ll buy the house at the end of the rental period, and you can face fees and other repercussions if you don’t follow through.
Rent-to-own vs. buying: What’s the difference?
If all goes well, the result of rent-to-own is the same as when buying traditionally, but how you get there is a little more complicated.
When you buy a house traditionally, you work with a real estate agent, look at homes that fit your purchase budget and then make an offer on the one you like. As long as the offer is accepted and nothing shows up on the inspection or appraisal, you close on the house and it’s yours.
With rent-to-own, you’ll still likely work with a real estate agent and look at homes. However, when you find one you like, you’ll enter into either a lease-option or lease-purchase agreement and start renting the house. After the rental period, you’ll have to buy the house with a mortgage and the traditional closing procedures.
Rent-to-own can be more expensive because there are usually fees associated with this option. You’ll have to pay those as well as the regular closing costs and fees when it’s time to buy the house. It can also be more costly because there are hidden fees and risks associated with rent-to-own (more on that below).
In most cases, you’ll also be responsible for most of the maintenance on the house while you’re renting. This is essential to consider, as it can be costly and take away one of the typical benefits of renting.
The risks of rent-to-own
There are two main risks involved with rent-to-own situations. The first is that property values in the area might decrease over the rental period, which could leave you paying more than the house is worth. If you signed a contract to purchase the home at $350,000 but at the end of the term the home is worth $250,000, you’ll be stuck paying the original agreed-upon price.
The second risk is that you might lose the house—and usually a decent chunk of your money investment with it. Here are a few scenarios that could happen:
- Sometimes, rent-to-own contracts have strict terms, which could risk the entire agreement. For example, the contract might specify that if you’re late or miss a rent payment one time, the rent-to-own contract is void.
- If you sign a lease-purchase agreement but can’t fulfill your obligation to purchase the home at the end of the lease term, you’ll likely have to pay a substantial fee.
- Rent-to-lease agreements typically come with higher-than-average rents. Additionally, you must pay for all house maintenance expenses. If you don’t purchase the home at the end of the term, you spend years paying more for no reason.
- At the end of the rent-to-lease agreement, you must get a mortgage from a lender. If you can’t secure a mortgage approval, you’ll be unable to purchase the home.
- If the home can’t pass a home inspection and therefore doesn’t qualify for a mortgage, you may be unable to buy the home.
The advantages of rent-to-own
Doing a rent-to-own option instead of a traditional purchase has several advantages, especially if your credit isn’t great. Rent-to-own lets you pick out a house you want to buy and lock in a price while still giving you time to build your credit or save money for closing costs.
It can also help you build equity instantly when you complete the purchase because of the portion of rent that’s allocated to the purchase.
Should you rent-to-own or buy?
If you’re considering rent-to-own, you’re probably wondering if it’s a better option than buying traditionally. It depends. Every situation is unique, but rent-to-own can sometimes be a better option.
Rent-to-own can give you a better feel for homeownership because you’ll be taking on most of the maintenance of the home. If you have a lease option, you can decide that you don’t like the responsibility of having to pay to fix or maintain things and that renting is better for you.
It can also be a better option for those who know they want to buy their own home but don’t have the credit or money in the bank to do that right now.
Rent-to-own lets you start building equity right away instead of all the money going to your landlord’s mortgage, and it gives you a few years to work on saving money, building a solid credit history and paying down debt.
No matter your reasons for wanting to go the rent-to-own route, it’s important not to try to go through the process alone. A qualified real estate agent with experience working with rent-to-own situations can help you find a suitable property and help ensure you understand what you’re signing up for.
Someone must walk you through the contract so you understand all the terms and potential fees.
They can also suggest and set up things like a home inspection if you want that done before entering into the contract.
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.
Alternatives to rent-to-own homes
If you decide rent-to-own isn’t for you and you can’t get a traditional mortgage, there are still other options. You can wait and spend a year or two working on your credit. Paying down debt, making sure all payments are made on time and building up your savings can put you in a much better position to buy a house and help you qualify for a better interest rate.
You can also look at other loan options such as an FHA or USDA loan. These often have lower credit score requirements and may require less money down than a conventional mortgage.
Lastly, you can also look into getting a cosigner for your mortgage if you have a friend or family member willing to take on the risk.
Bottom line: Rent-to-own can be a great avenue to homeownership as long as you work with professionals, understand what a rent-to-own contract entails and know what to look for in a suitable property.
Regardless of whether you plan to go the rent-to-own route or buy a home outright, your credit health will be important. A strong credit score can help you get mortgage approval, and typically, the better the credit, the lower your interest rate. Get started on improving your credit today by taking Lexington Law’s free credit assessment.
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Lexington did not write this content. It was provided by a third party.