How Rent-to-Own Contracts Work

With Rent-to-Own homes coming back into the spotlight amidst a competitive and tumultuous real estate market, many home buyers are looking to learn more about rent-to-own and rent-to-own contracts.

While there is a lot of information out there on what renting-to-own a home means, there’s not as much information about how rent-to-own contracts work. In this article, we’ll take a deep dive into rent-to-own agreements, what they cover, and how you can ensure you get what you need to get the best deal possible. 

What is a Rent-to-Own Home?

Before we get into the specifics of the rent-to-own contracts, it’s essential to make sure that we clearly define what a rent-to-own home is. 

A rent-to-own home is a home for sale that allows the buyers to live in the house before they complete the purchase. Rental payments are made monthly, like a typical rental situation, but the rent is slightly higher because a percentage of that rent goes towards paying the mortgage. At the end of the rental agreement, the buyers purchase the home, or if their contract stipulates, they may walk away from home without buying it. 
Typically, rent-to-own homes are a more financially viable alternative for those who are rebuilding their credit score or who can’t afford a 20%+ down payment on a home. 

What is a Rent-to-Own Contract?

A rent-to-own contract is like a hybrid between a rental agreement and a contract you’d have with a conventional home purchase. Rent-to-own contracts are made up of two parts:

  1. A standard lease agreement
  2. A purchase option

Some sellers prefer these to be combined into one document, like a separate agreement for each piece.

The Standard Lease Agreement

While the standard lease agreement is very much what you’re used to seeing if you’ve rented a home or apartment before. There are some things that you’ll want to be aware of before you decide to sign. 

  1. The seller still owns the home.
  2. You will not build equity during the rental period.
  3. The terms of tenancy can be a bit longer than a typical rental agreement depending on how long you and the seller agree on a reasonable amount of time for you to save up enough money to purchase the house or how long it will take to build up your credit score so you can qualify for a mortgage loan. Typically, the rental period can last anywhere from 1 to 3 years.
  4. The rental price will be higher than what you may be used to paying. This is because a percentage of the rent is going towards the mortgage.
  5. The owners of the home may still be responsible for maintenance, just like a regular rental agreement. Be sure to check and speak with the owners about what they’ll be accountable for during the rental period.

There will still be security deposits and fees required. For rent-to-own homes, you’ll pay an option fee. An option fee is like a smaller down payment made at the beginning of the contract period. Unlike traditional homes, where down payments can be over 20% of the house’s overall price, it’s usually between 1-5%, with an average of 3% of the overall cost. This is just like a mini-down payment, and part or all of it will go towards the home’s purchase.

However, if you decide not to purchase the home at the end of the rental period, you will not get your option fee back. It is nonrefundable.

Purchase Options

There are two types of purchase options you can choose from:

  1. Option to lease
    A lease option allows you to walk away from the home’s purchase after the lease agreement is done. It gives you a choice not to buy if, after living in the house, you decide it’s not a great fit or the neighborhood is not what you want, etc.

    If you choose to walk away from the home, whatever money you’ve put into it stays with the landlord/homeowner.

  2. Option to purchase
    The purchase option isn’t an option per se; it simply means that, no matter what, you intend to buy the house at the end of the lease agreement. By this time, you should have saved enough money and improved your credit score so you can get a loan with low interest rates to help you with this final step in the process.

    When you purchase the house, you will have the equity built as you rented, which only helps improve your creditworthiness and overall financial health, making you more qualified for other loans in the future. 

FAQs about Rent-to-Own Contracts

Q: How do I know what part of my payment is rent vs. what part of my payment goes towards the mortgage?

A: When creating the contract for your rent-to-own agreement, you and the seller/landlord should communicate in writing how much of the rent is rent and how much of that payment will go towards the mortgage. It’s important not to have any handshake deals on things like having something in writing in a contract means everyone is legally obligated to comply. 

Q: Do I need to make a down payment?

A: Yes, though it’s not called a down payment in the beginning. One of the fees that you’ll pay at the beginning of the rental period is called an option fee, the option fee is like a mini-downpayment, and it’s between 1 – 5% of the cost of the home, much lower than the 20%+ you’d pay with a more conventional home buying process. The option fee is non-refundable, and if you decided not to purchase the home in a lease option agreement, you would not get the option fee back.

There is also a more substantial down payment often required at the end of the rental agreement. The advantage of a rent-to-own agreement is that you can use the rental period to save up for this down payment and/or to improve your credit score so you can qualify for a home loan. 

Q: Can I use financing to help me purchase the home once the lease is up?

A: Yes! If you’ve used your rental period to pay down debt, increase your savings, and improve your credit score, you’ll be eligible for a traditional home loan as long as you meet all of the requirements. Some other loans are available to help low-income families and those who are rebuilding low credit scores, like the FHA, VA, and USDA loans. 

Q: What if I decide I don’t want to buy the house when the leasing period is over?

A: If you have a lease-option agreement, you can walk away from purchasing the house at the end of the rental agreement. If you have a purchase option, you will be legally obligated to buy the home during the rental period. Because of this restriction, many buyers prefer the lease option even if they’re confident they’ll buy the house at the end of the rental period. 

Q: Do the current owners act like landlords, or is everything up to me?

A: It’s imperative that your contract, like any lease agreement, should cover maintenance and repair responsibilities. It’s assumed that the landlord/sellers will act as normal landlords would during the rental period. Still, if you don’t have clear communication on responsibilities in writing as part of the contract, you may be liable for more than you can afford to take on. 

Q: Can I get an inspection done for a rent-to-own home?

A:  Yes! Not only should you get an inspection done, but you should also have a title search conducted before you sign anything. The inspection and the title search will uncover any issues with the home, including significant repairs needed if the seller owns the property and whether or not they’ve been paying their taxes. You don’t want to wait until you’ve purchased the home to discover you are now liable for years of back taxes or that the foundation and the roof need to be replaced. 

Q: Should I use a real estate agent for a rent-to-own deal?

Absolutely! Rent-to-own homes are listed on major real estate sites. Try to find an agent that has worked on rent-to-own agreements before so they can help review the contracts and guide you through the process with their experience and expertise. 

Q: How do I know if I’m getting a good deal?

A: Besides getting the title search and inspection done, it’s essential to have an attorney review all contracts before you sign them just to make sure everything is in place. Doing your research on properties, the area surrounding them, the real estate market, and using a real estate agent will help ensure you’re getting a fair and reasonable deal. 

Q: Can the landlords change the price of the home when it comes time to buy it?z

A: Typically, the price of the home is set based on current market prices at the time the contract is made. This can benefit if the real estate marketing is booming when your rental agreement is up because you are locked in at a lower price; however, it can be a con if the market has sagged and the home price in the agreement is now well above market value.

This is another reason while the lease option is a better deal, as you have the right to walk away from the home purchase in the event of several things, including a price that is above market value and no longer a good investment.

You also have some negotiating power as you’ve been living in the house and paying rent; the owners may be willing to negotiate a better price for the home when faced with the thought of not being able to see the house and having to put it back on the market. 

This is by no means a comprehensive list of questions and answers, but hopefully, it’s a good starting point.

Make Sure You Know Your Rights

No matter what, you must empower yourself with the knowledge you need to confidently go into your rent-to-own agreement. Make sure you get an inspection, a title search, and a real estate expert with experience to help ensure your rent-to-own understanding is detailed and complete, so you have the best experience possible.