What you need to know about rent-to-own contracts

brown and white concrete house

Is rent-to-own right for you?

Rent-to-own agreements can be helpful for certain homebuyers who need some time to save or increase their credit score before making a down payment or applying for a mortgage. 

But you should know exactly what you’re getting into before you sign any contracts. 

In this article, you’ll learn the basics of what a rent-to-own home is, how it works, the different types of contracts and fees, and how to know if it makes sense for you.

Buying a home doesn’t have to be complicated, though. Talk to a Flyhomes Agent to see what your options are in your market, what you qualify for, and how we can help you buy your next home sooner. 

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Key takeaways:

  • What a rent-to-own home is
  • How rent-to-own agreements work
  • The two main types of contracts
  • Rent-to-own fees and expenses
  • The pros and cons of rent-to-own properties

What is a rent-to-own home?

A rent-to-own home—also known as a lease-to-own home—is a house you rent for a period of time and then purchase when the lease is over. 

For some, this is a helpful way to eventually stop renting and buy a home.

People who enter rent-to-own agreements often do so because they don’t have enough in savings for a down payment or their credit isn’t quite high enough, at first, to secure a mortgage. 

Rent-to-own agreements allow you to live in the house while building up your savings and credit. It allows you the option to purchase at the end of the lease term, which can last anywhere from a few months to five years.

Since the future isn’t guaranteed, though, these types of agreements carry a certain amount of risk. 

It’s important to hire an experienced real estate attorney or real estate agent who can thoroughly explain your contract and its pros and cons as well as negotiate on your behalf.

How does rent-to-own work?

First, the buyer and the seller negotiate a contract, deciding between a lease-purchase or lease-option agreement (explained below). 

In a lease-purchase agreement, you and the seller will negotiate the purchase price upfront based on the home’s current or projected value. 

Then, you both determine if the option fee and a portion of your rent payments go toward the down payment and which housing expenses are your responsibility during the lease. You’ll also need to specify the length of the lease term.

Once you sign the contract, you’ll pay the option fee and begin renting the home. Then, when the lease is up, you’ll get a mortgage loan and purchase the property.

Different types of rent-to-own contracts

There are essentially two types of rent-to-own agreements. It’s important to understand which type you’re signing and the amount of risk each entails.

  1. Lease-purchase agreement: With this type of contract, you have to buy the home at the end of your lease at a price you agreed on when you signed the contract. This can be a risky decision, especially if you end up not liking the home or can’t obtain a loan at the end of the rental period. If you don’t buy the house, the seller could sue you.
  2. Lease-option agreement: In this case, you have the option to purchase at the end of the lease but are not legally obligated to do so. At the end of the rental period, you and the seller determine the purchase price, usually after an appraisal. Keep in mind that if you decide not to buy, you lose out on the equity you’ve built up so far.
red and white sign board on the lawn grass
A rent-to-own home is a way some renters have of building equity and saving up to enter the real estate market, but not all contracts are the same

Fees you pay when you rent-to-own

When you sign a rent-to-own agreement, you pay a non-refundable option fee, which is at least 3% of the home’s total purchase price. 

In some cases, though, it can be as high as 10%. This fee typically goes toward the down payment.

Your rent will also be higher than the market value, especially if your landlord is putting a percentage of it toward your down payment. The equity you build up through these payments is also nonrefundable.

Lastly, your landlord may also require you to pay for repairs, maintenance, property taxes, and even HOA fees while you’re renting the home.

Be sure to check the contract thoroughly to see which expenses you’re responsible for during your lease.

Advantages of rent-to-own agreements

1. You have a few years to save for a down payment and improve your credit score.

If you’re confident you’ll be in a good position to get a mortgage loan by the time the lease is up, then rent-to-own may be a good idea for you. 

In a seller’s market, this arrangement can be a great way to stake your claim on a home ahead of time and avoid intense competition.

2. You can experience the home and neighborhood before buying.

It’s normal to test-drive cars before buying, but you usually can’t do that with houses.

Rent-to-own allows you to experience what it’s like to live in a particular home and neighborhood before committing to a purchase. 

Plus, you can save on moving costs since you’re already living there.

3. You can purchase a home that doesn’t qualify for a conforming loan.

Rent-to-own homes aren’t just for people with little savings and low credit. 

Sometimes this option makes sense for those looking to purchase in expensive markets, where many home prices exceed conforming loan limits. 

Rent-to-own opportunities give these buyers time to save for the higher down payment that a jumbo mortgage loan may require.

Disadvantages of rent-to-own agreements

1. Rent is more expensive.

Since a portion of your rent payments goes toward future equity in the home, your rent will likely be higher than the market value. It’s common for rent-to-own tenants to pay hundreds of dollars extra in rent than their neighbors.

2. You may be obligated to pay for repairs and other housing costs.

Many landlords require that rent-to-own tenants pay for the home’s upkeep and property taxes. 

If an appliance breaks down or the house experiences major damage, it could eat a hole in your savings.

3. If you can’t buy the home, you lose the money you’ve already paid.

The option fee, rent payments, and housing expenses you pay are non-refundable. 

So if you don’t end up buying the home (or don’t qualify for a mortgage), you lose that money. 

And remember, if you sign a lease-purchase agreement and don’t buy, your landlord could sue you.

4. You may end up paying more for the home than it’s worth.

With lease-purchase agreements, the purchase price is locked in from the start. In this case, sellers often raise the price to accommodate for market appreciation

But if the seller overestimates the appreciation or if the market sees an unexpected downturn, you could find yourself stuck with an inflated purchase price.

5. The seller can cancel the contract if you don’t meet the requirements.

If you miss even one rent payment, you could face more than a late fee. 

In that case, a seller could void the contract and you’d lose the money you already paid towards the home. The same could happen if you don’t keep the home well maintained.

What other options do you have besides rent-to-own?

Although rent-to-own homes can be a viable way for some people who are strapped for cash to get into the market, it’s not the only way. 

You can also look into whether you qualify for one of the various down payment assistance programs that help you gather the funds needed to make a down payment.  

Or, see if you can apply for an FHA mortgage loan, which requires down payments as low as 3% in certain cases.

Rent-to-own homes give you the opportunity to build equity without a large down payment or mortgage loan

Rent-to-own homes can work for some people, especially if they fall in love with a particular house and want to live there while they save for the down payment.

But lease-to-own agreements can also be risky. 

Before you commit to anything, make sure you hire a professional real estate attorney who can research the landlord, explain the contract to you, and help you weigh the pros and cons.

Remember that everything in these agreements is negotiable—from the purchase price to the option fee to the expenses you’ll be responsible for. 

Be sure to ask your attorney the best way to negotiate your rent-to-own contract so that it poses the least amount of risk to you.

Buying a home doesn’t have to be complicated, though. Talk to a Flyhomes Agent to see what your options are in your market, what you qualify for, and how we can help you buy your next home sooner. 

About the author: Jenny Rose Spaudo is a freelance PropTech and finance copywriter as well as a happy Central Florida homeowner. She’s written for clients like Edward Jones, AAA, PropStream, Jetty, and Knock, and her writing has appeared in publications like Business Insider and GOBankingRates. Connect with her on LinkedIn and visit her website to learn more.

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