How Does Rent-to-Own Work?

Rent-to-own is a popular option for individuals who want to move into a home while working towards ownership. This arrangement allows renters to lease a property with the opportunity to buy it at the end of a predetermined period. During this lease term, a portion of the monthly rent payments may contribute towards the home’s future purchase price.

If you want to buy a home, a financial advisor can help you reach that goal by creating a financial plan.

What Is Rent-to-Own?

Rent-to-own agreements offer an alternative path to homeownership for those who may not currently qualify for a mortgage. In a rent-to-own arrangement, tenants lease a property with the option to purchase it at the end of the rental term. Typically, these agreements span one to three years.

During the lease period, a portion of the monthly rent payments is allocated towards the eventual down payment or purchase price of the home. This can help renters build equity and improve their credit score, making it easier to secure a mortgage in the future. Additionally, an upfront option fee–usually 1% to 5% of the home’s purchase price–is paid to secure the right to buy the property.

Types of Rent-to-Own Agreements

Lease-option. This gives the tenant the right, but not the obligation, to buy the property at the end of the lease term.
Lease-purchase. This obligates the tenant to buy the property once the lease period ends.

How to Create a Rent-to-Own Agreement

Follow these eight common steps to create a clear and fair rent-to-own agreement that benefits both the landlord and the tenant:

Determine the terms. Start by outlining the key terms of the agreement, including the duration of the rental period, the monthly rent amount, the purchase price and the portion of the rent that will go towards the purchase.
Conduct property appraisal: Make sure that the property’s value is accurately assessed by a professional appraiser. This will help establish a fair purchase price for both parties.
Draft the agreement: Write a detailed rent-to-own contract that includes all agreed-upon terms. This should cover the responsibilities of both the tenant and the landlord, including maintenance, repairs and property taxes.
Include an option fee: Specify the non-refundable option fee the tenant will pay for the right to purchase the property. This fee is typically a percentage of the purchase price.
Define maintenance responsibilities: Clearly outline which party is responsible for property maintenance and repairs during the rental period.
Consult legal professionals: Both parties should have their legal representatives review the agreement to ensure it is legally sound and enforceable.
Sign the agreement: Once both parties are satisfied with the terms, sign the agreement. It’s advisable to have the signing witnessed or notarized.
Record the agreement: In some jurisdictions, it may be beneficial to record the rent-to-own agreement with the local county recorder’s office to provide public notice of the arrangement.

Benefits of Rent-to-Own Agreements

A couple reviewing a rent-to-own arrangement.

Rent-to-own agreements offer unique flexibility and potential financial advantages for both tenants and property owners. Tenants who need an alternate path towards home ownership can lease a property with the option to purchase it later, while property owners benefit through various financial and logistical perks.

Benefits for Tenants

Path to homeownership: Rent-to-own agreements offer a gradual path to buying a home, which is especially beneficial for those with limited immediate funds.
Build equity: A portion of the rent paid often goes towards the purchase price, allowing tenants to build equity over time.
Trial period: Tenants can live in the home and experience the neighborhood before committing to a purchase.
Credit improvement: Regular rent payments may help improve credit scores if they are reported to the credit bureaus, which can also help get future mortgage approvals.

Benefits for Property Owners

Steady income: Property owners receive consistent rental income, even if the agreement does not oblige the tenant to purchase the home at the end of the contract period.
Higher rent: Rent-to-own agreements often allow owners to charge higher rent due to the option to buy. Depending on the contract, some or even all of the option money may be applied to the eventual purchase price.
Potential sale: The agreement increases the likelihood of selling the property without the need for additional marketing.
Tenant responsibility: Tenants typically take better care of the property, as they have a vested interest in its condition.

Pitfalls of Rent-to-Own Agreements

Rent-to-own agreements can be appealing, but they come with several potential pitfalls for both tenants and property owners. Understanding these challenges can help individuals make informed decisions.

For Tenants

Higher costs: Monthly payments are often higher than regular rent, which can strain finances.
Forfeiture risk: Failure to purchase the property by the end of the lease can result in losing the extra money paid toward ownership.
Maintenance responsibilities: Tenants may be required to handle maintenance and repairs, adding unexpected expenses.
Market fluctuations: Property values might decrease, leaving tenants paying more than the home’s worth.

For Property Owners

Uncertain sale: If tenants have a contract to buy and decide not to proceed, the seller could face potential income loss and will need to find new buyers. Depending on the contract, however, tenants may forfeit any option fees or rent credits that they have paid.
Maintenance disputes: Disagreements over repairs and upkeep can arise, complicating relationships.
Market risk: Locked-in purchase prices might be lower than future market values, resulting in financial losses.
Legal complexities: Drafting and enforcing rent-to-own contracts can involve legal complexities and costs.

Bottom Line

A couple researching the benefits and drawbacks of a rent-to-own arrangement.

Choosing a rent-to-own arrangement can be a practical solution for individuals who may not have the credit history to qualify for a traditional mortgage, or enough capital for a down payment. This strategy offers financial flexibility as renters become owners, allowing potential homeowners to save for a down payment and possibly even enhance their credit profile over time. Both parties should be aware of the higher costs, maintenance responsibilities and legal complexities involved

Tips for Homebuyers

If you’re thinking about buying a home, SmartAsset’s home affordability calculator can help you estimate how much property is right for you.
If you need help saving for a down payment, a financial advisor can work with you to set and reach goals. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.