How does renting to own work?
You're probably familiar with a standard rental agreement: You sign a lease for a preset period of time, during which you're required to make rent payments to your landlord. That money is your landlord's to keep in full, and the only thing you get in exchange is a roof over your head.
With a rent-to-own agreement, you sign a contract that gives you the right to buy the home you're renting after a specified period of time -- usually two to five years. As part of that contract, your landlord will agree to hold back a certain portion of your monthly rent payments that will go toward your home's purchase price, thereby making it easier for you to afford that home once your rental period is up, while also allowing you to effectively build equity in that home even while you're technically just a renter (though to be clear, you won't be able to borrow against that equity until you actually become the owner).
Of course, that's the simplified version. There are numerous specifics that come into play with rent-to-own homes that can vary from contract to contract.
What are the different types of rent-to-own agreements?
Rent-to-own homes usually come with one of two legal arrangements behind them:
- A lease agreement with the option to buy, which gives you the right to buy the home you've been renting but does not obligate you to do so.
- A lease-purchase agreement, which obligates you to buy the home you've been renting at the end of your contract.
Clearly, the former arrangement offers more flexibility than the latter. If your circumstances change, or you decide you no longer want to buy the home you've been renting, you're effectively off the hook. With the latter, you're locked into buying that home.
What rent-to-own contract terms should you be familiar with?
Once you determine what type of rent-to-own agreement you'll be entering into, you'll need to review the terms of your contract to understand what obligations you have under that lease. Specifically, you'll be looking out for language related to:
- Purchase price: How much will you be expected to pay for your home once you're ready to buy it? Will you pay a preset price that's stated up front? Or will the sale price be a function of that home's market value at the time of purchase? These details should be spelled out in your agreement.
- Monthly payment: What will your monthly payment be, and how much of it will go toward rent versus your eventual down payment?
- Maintenance, insurance, and taxes: Who will be responsible for maintenance on your home, property taxes, and homeowners insurance while you're renting it? In a standard lease agreement, those costs are the landlord's responsibility. In a rent-to-own arrangement, you may need to share in those costs if that's what your contract dictates.
- Option fee: This is a one-time, nonrefundable fee that gives you the right to purchase your home at the end of your lease agreement. This fee is typically equal to at least 1% of the home's purchase price or current market value, but it can be higher.
- Length of lease: How long will you rent the home before buying it?
- Mortgage application: If you're buying your home at the end of your lease, you'll need to apply for a mortgage, just as you would if you were buying a home the traditional way. But what happens if you don't qualify for a mortgage? And how much time will you be given to get approved? These terms should be spelled out clearly.
Generally speaking, there are no preset rules when it comes to rent-to-own agreements, and one contract can differ drastically from another. Also, as is the case with most lease agreements, the terms of your rent-to-own agreement are negotiable, so if there's something in your contract you don't like, you can always speak up about it -- or walk away if the terms don't work for you.
Benefits of rent-to-own agreements for tenants/buyers
As a potential buyer, there are plenty of good reasons to enter into a rent-to-own contract. For one thing, if you've found a home you really like in your target neighborhood, but you need time to build your credit and improve your finances, then a rent-to-own setup spares you from losing that property to another buyer who can afford to purchase it right away.
Furthermore, when you rent to own, you're effectively forced to save money toward your home's down payment. If you're not great at budgeting or saving money in general, it's a good way to stay on track. And remember, some of the money you pay your landlord each month goes toward your down payment, so you're not throwing that entire sum away for no long-term benefit, as would be the case with a traditional lease agreement.
Additionally, if you enter into a rent-to-own agreement with the option to back out and not go through with the purchase, you'll have an opportunity to see whether the home in question is really right for you. Sometimes, problems with homes don't reveal themselves during an initial inspection; they only become obvious once you've been living in that home for a while. With a rent-to-own agreement, you minimize the risk of unknown repairs that traditional homebuyers face.
The same holds true for vetting your neighborhood -- you might think you've found the right area to settle down in, but if, after a year or two of living there, you change your mind, you may be able to back out of buying your home if your rent-to-own contract allows for that. When you buy immediately, you're more likely to feel stuck.