Owning a home is an important goal for many people. But with mortgage, downpayment and credit requirements, many can’t yet afford to buy as soon as they’d like. For some in this situation, rent-to-own homes are an attractive option. It can give motivated people a means to assume ownership in stages, although, like many loan arrangements, it carries some risks. We’ll explore the pros and cons of rent-to-own homes here, but you may want to consider speaking to a financial advisor to learn how home ownership can benefit your individualized long-term plans.
What are Rent-to-Own Homes?
As the name suggests, rent-to-own homes are living units you can rent for a period of time, usually at least three years. Then, you’ll either have the option or the obligation to buy. In addition to rent, you’ll pay an extra premium that funds your future down payment. Also, you may need to pay for maintenance, repairs and utilities. There’s often an ‘option fee’ you must pay up-front, which may or may not be applied to your down payment.
Rent-to-own landlords may be private owners or a company. But in any arrangement, there will be a contract that establishes certain conditions. These include the length of the rental, total down payment, conditions and payment schedules.
You should note that there are fewer standards and regulations around rent-to-own agreements than standard mortgages. Contract terms vary widely, and as with any other legal agreement, the devil can be in the details. You’ll want to review any contract with great care-and probably seek legal advice before you sign. Additionally, conditions are not always set in stone, especially with individual sellers.
Is a Rent-to-Own Home for You?
Rent-to-own arrangements can work for people who can’t qualify for a mortgage, either due to bad credit or insufficient down payment funds. Theoretically, it lets buyers build up a down payment while regular rent payments improve their credit.
But it also can work for people who have money and good credit. For instance, contract workers and other members of the ‘gig economy’ may not qualify for conventional mortgages because they don’t have a full-time job with a single employer. Foreign nationals with good jobs but short credit histories are other possible candidates.
Whatever your reasons, you have some negotiating power in these contracts. You often can haggle over payment terms, maintenance and option fees. This is a benefit if you know how to drive a bargain. But if negotiation isn’t a strength, you might want to consider another option. It’s very easy to get stuck in a contract on very bad terms.
Rent-to-Own Homes: The Pros
In the best cases, rent-to-own homes deliver a variety of benefits:
- You only move once: If you’re ready to move but can’t afford a mortgage, a rent-to-own house can save you a round of moving costs. Rather than move, rent, buy and move again, you only move once.
- Build up a down payment: Most rent-to-own contracts include a monthly contribution to your down payment on top of your rent. In some cases, the option fee may also apply to the down payment, but this is much less common.
- Improve your credit: On-time rental payments will bolster your credit score before you buy. In turn, better credit increases the likelihood you’ll qualify for a standard mortgage and good interest rate. The rental period can also give you time to pay down debt.
- Rent (then own) where you want: It can be difficult to move to your dream location without having a lot of cash. Rent-to-own allows you to establish a foothold in an area you want to live before you can afford to buy in with a mortgage.
- Lock in a bargain price: In some cases, you can agree on a sale price before you sign the rent-to-own contract. So if the home appreciates in value, you could be buying at a much lower price than other buyers in the same area.
Rent-to-Own Homes: The Cons
While rent-to-own has many potential upsides, they’re evened out by some considerable risks or possible complications:
- Buying could take years: Some rent-to-own homes have the option to buy after as little as three years, but there are much longer terms. If homeownership is a goal for next year or the year after, it may be better to open a separate down payment savings account and keep renting.
- The housing market could cool down: Hot housing markets don’t always stay hot. If you lock in a rent-to-own sale price when the market is up, you’ll be stuck with an inflated price tag if the market has plummeted by the time your option or obligation comes due.
- Extra responsibility: Rent-to-own agreements may not hold you responsible for any maintenance. Or, they can demand you do it all. In some cases, you might be obligated to pay for whatever a homeowner would pay, including repairs or upgrades that could cost thousands of extra dollars. Rent-to-own houses quickly can become much more expensive if you don’t factor in all the potential costs.
- Extra monthly costs: It’s great to sock away down payment money every month. But it does mean your housing costs will be higher than if you were just renting.
- Mortgage pre-approval: It’s possible you may need to get pre-approved for your potential mortgage before you sign a rent-to-own agreement. But it’s your credit score and a debt-to-income ratio that set the mortgage terms and interest rates. As a result, you might lock in a higher interest rate than you would with a few extra years to improve your finances and creditworthiness.
Are You Ready for a Rent-to-Own Home?
If you’ve found the home of your dreams and it’s a rent-t0-own, you still need to ask important questions before making any commitment:
- Is the price right? If you’re moving to a bigger space or a more expensive community, monthly payments could be more than you currently pay. Can you afford the rent increase and the extra charge that goes towards your down payment? Will the option fee deplete your savings? If you’re responsible for maintenance, do you have a separate fund for repairs?
- Is it a lease-option or lease-purchase? This is an important distinction. With lease-option, you may exercise your right to buy at the end of the renting period. You also can walk away so long as you’ve met all contractual obligations. With lease-purchase, however, you also are obligated to buy the home. If you still are unable to complete the sale because you can’t qualify for a mortgage or scrape together a sufficient down payment, you technically could forfeit everything you paid in during your rental term. If there’s any question of not meeting the purchase or mortgage requirements, you probably want to avoid lease-purchase agreements.
- Are you sure the home is OK? You can’t always see the problems in a house on a walk-through. If you’re considering rent-to-own, take the same steps you would if you were buying. Get an appraisal and inspection before you sign any contract. It requires more money up front, but it could save you thousands, and the heartbreak of buying a lemon of a home.
- Is the contract fair and transparent? Never accept a contract at face value, and if at all possible, consult a lawyer before signing. Make sure there are no deceptive or overly strict conditions. Whatever you object to, remember that rent-to-own contracts almost always are negotiable.
The Bottom Line
In certain circumstances, rent-to-own homes can be a way to move into a neighborhood, house or apartment you love before you’re ready to take on a mortgage. When terms are fair and there is renter/buyer protection in the contract, it can even be a bargain, especially if you’re buying into an area you expect will become more expensive.
That said, rent-to-own can become a financial disaster if you can’t afford the higher payment (rent plus down payment contribution) or option fee. The same could happen if you’re on the hook for all repairs and the home has major structural problems. In any rent-to-own agreement, you will be taking on more responsibility than you would as a renter. Make sure you’re in a position to handle it.
Tips for Homebuyers
- If you’re ready to buy but still fall short on the down payment, there may be options beyond rent-to-own homes. There are many first-time homebuyer programs that require smaller down payments or provide grants to help increase your buying power. Before signing any contract, explore the full range of options.
- Buying a home likely will be the biggest purchase you’ll ever make, and consulting with a financial advisor can help you determine if you’re truly ready. 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 interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.