If you don’t have the down payment to purchase a home, rent-to-own housing can be a great option. You’ll be able to set money aside and possibly move into an ownership position at the end of the term. To qualify for a rent-to-own home, you’ll need steady income and a decent credit score, as well as money for an option fee, which will cost thousands of dollars.
Rent-to-own housing has less strict requirements than a mortgage, but you’ll still need proof of income and a decent credit rating, as well as the ability to qualify to purchase the home at the end of your lease.
What Is Rent to Own?
With rent to own, you sign an agreement to rent a place for a specific timeframe, along with the option to purchase the home at the end of that period. In addition to letting you make yourself at home in a place you’ll own in the future, these agreements often also let you put part of your rent payment toward a down payment on the house. The rental price is usually higher than it would be without the rent-to-own option, but the renter may find it’s worth the extra expense to have that automatic savings feature built in.
Since these homes can be more expensive, renters who aren’t interested in eventually taking ownership of the property may see that it’s not a viable option. However, if you want to rent a property that is promoted as rent to own, it’s worth contacting the owner to see if you can negotiate a lower rental price without the rent-to-own feature.
The process of qualifying for a rent-to-own home is similar to what you’ll experience in standard rental arrangements. Primarily, the owner of the property will want to make sure you can be relied on to pay the rent each month, so you can expect a credit check and employment verification. Each property owner will have his own application process
However, even without these requirements, you may want to determine whether you qualify before you opt for a rent-to-own situation. If you get to the end of your term, only to find your credit score and income still aren’t enough to qualify for a mortgage, you’ll have paid extra for rent, only to not be able to use that money toward a down payment. For this reason, visiting a mortgage company to prequalify for a mortgage loan may give you insight into whether a rent-to-own home is the right choice for you.
Rent-to-Own Financial Requirements
In addition to the standard rent-to-own qualifications you’ll need to meet, you may also find the fees are higher than what you’d pay to get into an apartment or standard rental home. You’ll probably be asked to put down a deposit in the form of first and/or last month’s rent, as well as a security deposit. But there will also be an option fee that ranges from 2.5 to 7 percent of the total purchase price of the home.
It's important to note that your option fee won’t be refundable. That means if, for some reason, you don’t qualify to purchase the house at the end of your rental term, you could lose the money. However, it’s also important to realize that this fee is negotiable, so don’t assume you automatically have to pay whatever rate the owner has set.
How Rent Premiums Work
In addition to the option fee, you’ll also pay extra each month in rent on a rent-to-own property. This is called a rent premium, and it varies from one contract to another. The good news is, this money goes into an escrow account, and when you’re ready to purchase, it counts toward your purchase price.
A rent premium is an increase over the going market rate for a comparable rental in that area. So, for example, if the property owner would typically be able to rent the home for $1,000 a month, it might rent for $1,200 a month for a rent-to-own tenant. That extra $200 a month would go into escrow and be used toward the purchase price, unless you back out of the purchase, at which point the homeowner would keep it.
Lease Option Versus Lease Purchase
There’s more than one type of rent-to-own contract, with one being more desirable than the other. A lease-option contract is the most desirable, as it simply gives you the option to make the purchase at the end of your term. If you choose not to buy it, you’ll be allowed out of the contract without any repercussions.
The other, less appealing, option is a lease-purchase contract. In this instance, you’re obligated to buy the house at the end of your term. Sometimes the wording in the contract doesn’t make it clear which type of lease it is, so you may want to check with a real estate attorney before agreeing to anything. Before you sign such a contract, take a hard look at your budget, including checking an interest rate calculator to adjust for any increases that may happen in the time you lease the house.
Ideal Rent-to-Own Candidates
Even if you meet the basic rent-to-own qualifications, it may not be the best choice for you. If you aren’t sure you’ll be staying in the same general area for the next decade or so, you’re probably better off with a basic rental situation. The best candidates for rent to own are those who plan to live in the house for at least a few years after they take ownership of it.
Rent-to-own agreements have also become popular in markets where purchasing a home is very difficult. If you live in a city like San Francisco, for instance, where the median home price is $952,400, rent to own can allow you to gradually buy down the purchase price until it reaches a more manageable level.
Advantages of Rent to Own
As you’re browsing rent-to-own homes listings, you may wonder whether it’s a good move. There are several pros of this type of homebuying setup, many of which revolve around the extra time it gives you. You’ll be putting a portion of your monthly rent toward your future purchase, so that helps with the need to save for a down payment. You’ll also have extra time to improve your credit score if you find it’s currently too low to qualify for a mortgage.
Another advantage of renting a home in return for future ownership is that you lock in a price. When you reach the point where you’re allowed to turn your rental into a purchase, you’ll be paying the market value placed on the home at the time you signed the rental contract. This could save you money, particularly if you live in an area where real estate prices are on the rise.
Of course, what usually draws a person to a rent-to-own home is the fact that you can get into a home immediately, rather than having to stay in a temporary situation for another couple of years. This helps you work toward buying the house while establishing a home there.
Disadvantages of Rent to Own
The biggest disadvantage to a rent-to own home is the option fee you’ll be asked to pay when you sign the contract. You’ll lose the money if for some reason you have to end the contract along the way, and it can be thousands, if not tens of thousands, of dollars. If for some reason the homeowner is served a foreclosure notice during your tenure, you could be forced to leave the property with very little warning. You can also be evicted if you fail to pay the rent, forfeiting your option fee and any other deposits you paid.
Another disadvantage is that you won’t be able to lock in an interest rate at the start of your rental period. That means when it’s time to buy, you’ll have to qualify for a mortgage and even if you’re approved, you’ll be charged the interest rate in place at that time. You can find interest rate calculators online that will help you see what your monthly payment might be if rates rise by a couple of percentage points or more.
Rent-to-Own Property Maintenance
When you rent a property, usually the property owner or landlord is required to take care of any repairs. Unfortunately, this isn’t always the case with a rent-to-own home. You’re in a murky area since the home will someday be yours. Read the terms of the contract closely and make sure you have in writing who will handle landscaping, home repairs, plumbing, heating and air conditioning issues and anything else related to the home’s upkeep.
As you’re browsing rent-to-own home listings, you should also keep in mind that this is a home you’re putting money toward buying. That means you should approach the home you choose as you would a home purchase. Request a home inspection and make sure the property is in good condition before you sign on the dotted line.
Finding a Rent-to-Own Home
As you search for rent-to-own homes listings, you may notice something right away. There aren’t as many rent-to-own homes as there are rentals and homes for sale. In fact, one real estate agent estimates that rent-to-own homes make up only 5 percent of the total home sale market. You’ll probably notice many rent-to-own homes are either foreclosures or located in more remote areas.
The best route to a great rent-to-own home may be a less direct one. If you can find a homeowner who has a property for rent and talk that person into a rent-to-own setup, you’ll be more likely to get the home you want, in the area of town you want. One of the best courses of action is to look for a reluctant landlord – someone who was forced to rent a home that maybe sat on the market for a while and couldn’t sell.
Renting to Own Versus Buying
When it comes down to it, only you can decide if renting to own is the right option for you. If you can qualify for a mortgage, you’re typically much better off purchasing the home, rather than paying rent for a period of time, then buying it. Before you make the decision to rent to own, crunch the numbers and research mortgage options like Federal Housing Administration loans that will help you get into the house you want without renting.
If you’re paying $1,200 a month, with only $200 a month going in escrow toward the purchase, over two years you’ll have spent $24,000 on rent. However, if you’d lived in a home for 24 months, a large chunk of your monthly payment would have gone to interest. Use an interest rate calculator to determine exactly how much you would have paid over those 24 months and compare to what you would have spent on rent.
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- Federal Trade Commission Consumer Information. "What You Need to Know About Rent-To-Own Home Deals." Accessed April 15, 2020.
- USA.gov. "Homeowners and Renters Insurance." Accessed April 15, 2020.
Stephanie Faris has written about finance for entrepreneurs and marketing firms since 2013. She spent nearly a year as a ghostwriter for a credit card processing service and has ghostwritten about finance for numerous marketing firms and entrepreneurs. Her work has appeared on The Motley Fool, MoneyGeek, Ecommerce Insiders, GoBankingRates, and ThriveBy30.