Owning a home is a major life goal for many people. However, the combination of rising house prices and stagnant wages has made it much harder for even the most financially responsible adults to scrape together the minimum down payment for a house—not to mention the strict credit requirements for getting a mortgage.
Rent-to-own agreements may seem like the perfect solution since they combine some of the features of buying and renting. But how exactly does renting to own work, and what’s the catch?
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How does rent to own work?
Rent to own (also called lease to own) is essentially what it sounds like: a compromise between renting and buying something. It’s a type of lease agreement that involves an option to buy the product or property at the end of the lease period.
The term “rent to own” can refer to lease purchases for just about any type of product—including furniture and appliances. However, this article will mainly discuss rent-to-own homes since houses are the most common object of lease/purchase agreements.
Build equity by paying rent
In most lease-to-own contracts, some portion of the rent you pay goes toward your eventual purchase of the home (if you end up buying it). This could be a fraction of your rent (like 25%), or it could be your full rent, depending on the contract.
Types of rent-to-own contracts
There are two distinct types of rent-to-own contracts, lease-option and lease-purchase. The terms are often used interchangeably. However, it’s important to know which type of agreement you’re signing up for because they have very different implications for what happens at the end of your lease.
Here’s how lease-option and lease-purchase agreements differ:
- Lease option: You have a choice of whether or not to buy the home at the end of your lease contract.
- Lease purchase: You must buy the home at the end of the lease contract.
The last thing you want is to find out you’re committed to buying a house when you thought you were signing up for a lease option contract. Make sure to clarify the terminology with your landlord before you sign.
What are the pros and cons of rent to own?
Because lease to own falls somewhere in between renting and buying, it has some of the benefits and drawbacks of each.
Pros of rent to own
- More time to save up a down payment: With rent to own, you can start building equity in your dream home, even if you can’t afford the down payment on a mortgage. It’ll also give you an extra couple of years to budget and save up.
- More time to build credit: If you can’t qualify for a mortgage right now because you don’t meet the credit score requirements to buy a house, then opting for lease to own will buy you some time to build credit if you have none or fix your credit before buying a house (if you previously damaged your score somehow).
- Option to change your mind later: Signing a lease-to-own contract with a landlord gives you more flexibility than buying a house outright. You’re essentially getting a trial period where you can see how you like living in the house and the neighborhood before you commit to making the purchase.
- Less competition when it’s time to buy: As part of your agreement, you’ll pay an option fee (a percentage of the home’s value), which goes toward your future purchase and secures your right to buy the home. This gives you first dibs over other potential buyers, which is a big deal in today’s competitive housing market.
Cons of rent to own
- More expensive than renting: You’ll be paying more than the market rate on a lease-to-own home, which makes it more expensive than just renting a house or apartment. This is to make the agreement worthwhile to the seller, but it’s bad for you, the renter/buyer.
- You may need to pay maintenance fees: Unlike traditional leases, lease-to-own contracts often offload some of the responsibility for home maintenance fees onto the tenant. Depending on your contract and the condition of the house, this could add up to significant expenses.
- Still requires a mortgage later down the line: If you decide to purchase the home at the end of your rent-to-own contract, you may still need to take out a mortgage to cover the remaining cost of the house. This is an issue if the main attraction of a rent-to-own house is that you don’t want to take out a home loan.
- No guarantee that the house won’t lose value: There’s a chance that the home you’re renting won’t be worth as much at the end of your lease agreement as it was at the start. If you’ve agreed on a purchase price with your landlord, then this means you could lose money on the deal.
What is the legal status of rent to own?
If you’re considering signing a rent-to-own agreement and have started to research the issue, you might have read confusing or conflicting reports about the legal status of the contract you’d be signing.
Fortunately, this isn’t something that you need to worry about anymore. Here’s why:
The legality of rent to own has been simplified over time
Because rent to own occupies a gray area between leasing and purchasing, there’s been disagreement in the past about whether to classify these contracts as traditional lease contracts or “credit sale contracts.”
Many states have classified lease-to-own contracts as lease agreements, but four states (Minnesota, Wisconsin, New Jersey, and Vermont) have classified them as credit sales. 1
This had implications for consumers in terms of whether interest rate caps applied and what disclosures landlords/sellers were obligated to provide tenants/buyers. The Consumer Rental Purchase Agreement Act was introduced to address this and create a uniform standard that would protect consumer rights during lease/purchase transactions.
Thanks to this legislation, the state you live in doesn’t need to be a major consideration when deciding whether rent to own is right for you (although it’s still smart to check your local laws and consult with an attorney if you have questions).
When is rent to own a good idea?
Rent to own isn’t for everybody, but it may be a good idea for you if you want to buy a home but you aren’t quite ready to take out a mortgage.
Here are signs that lease to own could be right for you:
- You’re working on rebuilding your credit and don’t want to get a mortgage right now
- You can’t afford a home yet, but you expect your income to increase in the next year or two
- You aren’t 100% sure whether you want to live in a certain area and want to try it out first
In these cases, rent to own could save you money, improve your odds of mortgage approval, and give you peace of mind when it comes time to finally buy a home.
When to avoid rent to own
There are some instances when rent to own may not give you any real benefit:
- You have credit issues that would disqualify you from a mortgage (e.g., bankruptcies or foreclosures)
- You expect your financial situation to be the same in a couple of years
The unfortunate reality is that the majority of rent-to-own contracts don’t actually lead to the purchase of a home. 1
To avoid wasting the extra money you’re spending (remember, rent to own is more expensive than ordinary renting), be sure to carefully evaluate your options and think hard about what your goals are before getting a rent-to-own home.