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A rent-to-own agreement allows you to live in a home and pay rent for a predetermined amount of time before buying it. A portion of your monthly rent might go toward your down payment. In this way, you can save gradually and begin building home equity as you go. But there are potential downsides to consider. Fees may apply, and there's no guarantee that you'll qualify for a mortgage at the end of the lease term. Read on for pros and cons of rent-to-own programs.
How Does Rent-to-Own Work?
Rent-to-own homes allow you to pay rent for a certain amount of time. When the lease term ends, you'll have the opportunity to buy the property at an agreed-upon price. It's similar to a standard rental agreement but includes the option to buy the property at a later date. Some of your monthly rent payment might go toward the eventual purchase price, depending on the contract.
You'll likely be charged a nonrefundable option fee upfront that can range anywhere from 2% to 7% of the home's value. If you decide to buy the home, this fee generally goes toward the purchase price.
Who Are Rent-to-Own Homes Best For?
If you want to buy a home but aren't financially ready to do so, a rent-to-own contract could provide a workaround. Here some scenarios where it might make sense:
- You're struggling to save a down payment. Saving an adequate down payment can be challenging if a large chunk of your income is going toward rent. It's possible to get a home loan with a low down payment, but it could still amount to tens of thousands of dollars. The right rent-to-own agreement can make it easier to get there.
- You need time to work on your credit. You'll likely need a credit score of at least 500 to qualify for a home loan, though some mortgage lenders may require a score as high as 700. A rent-to-own home could give you time to improve your credit score and get your finances in order before buying a home.
Lease-Option vs. Lease-Purchase
There are two main types of contracts for rent-to-own homes:
| Lease Option | Lease Purchase | |
|---|---|---|
| How it works | You'll have the option to buy the home when the rental agreement ends, but you're under no legal obligation to do so. You can walk away when the lease expires if you change your mind. | You'll be legally obligated to purchase the home at the end of the lease agreement, even if you've changed your mind or can't afford it. |
| Party responsible for maintenance costs, insurance and property taxes | Generally the landlord | Generally the tenant-buyer |
Benefits of Rent-to-Own
- It can help you save for a down payment. If you direct a portion of your rent payment toward the purchase price, it could add up to a sizable down payment you may have struggled to save otherwise. It can also help you build home equity.
- It gives you time to strengthen your finances. You could use your rental period to pay down debt, improve your credit score, pad your savings and increase your income before buying a home.
- You can lock in your price. You'll likely know the purchase price from the beginning, which can give you peace of mind and allow you to financially prepare.
- You won't have to move. Moving can be a hassle and has costs of its own. You could save thousands on supplies, furniture, movers and more.
Downsides of Rent-to-Own
- You may pay higher-than-average rent. Your rent may be higher with a rent-to-own property, especially if part of your payment is going toward the purchase price.
- There may be fees. Nonrefundable option fees vary, but you could lose money if you decide not to purchase the home.
- You may have to cover maintenance costs, insurance and property taxes. That could add up to major out-of-pocket expenses—especially if your roof springs a leak or your air conditioning goes out.
- Financing isn't guaranteed. You'll still have to qualify for a mortgage if you finance your home purchase. Closing costs can also add an extra 2% to 5% to the total.
Is Rent-to-Own a Good Idea?
There are pros and cons of rent-to-own homes. Whether it's right for you will depend on your financial situation and goals around homeownership. Your price-to-rent ratio can help clarify if renting or owning is the better option. To calculate it, divide the median home price in your area by your annual rent cost. A price-to-rent ratio that's less than 15 suggests that buying might make the most financial sense. In this case, a rent-to-own agreement could help you achieve that goal.
However, there are potential fees and expenses to consider, and your rent payment may be on the higher side. Building a strong financial foundation is important—especially if you'll be obligated to buy the home at the end of your lease term. If you're interested in rent-to-own homes, choose a company that's well established in your area and has positive reviews.
Alternatives to Rent-to-Own
- First-time home buyer assistance: Check with your state to see if you qualify for any first-time home buyer programs. That may include loans and grants to help cover your down payment or closing costs.
- Federally insured home loans: Government-backed mortgages are known for their low down payments and softer eligibility requirements. With an FHA loan, for example, first-time home buyers could get a mortgage with a down payment as low as 3.5%.
- Saving a down payment on your own: Another option is to save a down payment on your own while renting. Money market accounts, high-yield savings accounts and certificates of deposit (CDs) can allow you to earn interest on your savings until you're ready to buy.
The Bottom Line
A rent-to-own agreement could make it easier to buy your first home, assuming the contract terms make good financial sense. You can use the rental period to strengthen your down payment and improve your credit.