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How Does Rent-to-Own Work, and When to Consider It?

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How Does Rent-to-Own Work, and When to Consider It?
4 min. read
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Looking to buy a home but don’t quite have the finances? You might have heard that rent-to-own is the ideal solution. But what exactly is rent-to-own, and how does it work? In this guide, we’ll cover the basics and take a look at whether it’s the right choice for you.

The Basics

A rent-to-own home is based on an agreement that allows you to buy the property after several years of renting it. As a tenant, you will pay an upfront fee, ranging between 1% and 5% of the purchase price, which secures the option to buy the property. On top of this, you will also pay a bit extra in rent each month, which is added to your down payment for purchasing the home. The length of the agreement varies from case to case, often ranging between 1 and 5 years.

Lease vs. Purchase Agreements

Despite the name, not all rent-to-own agreements result in ownership of the property. So it’s important to understand the terminology before you sign any documents.

There are two types of rent-to-own contracts:

  • Lease option: you have the option to buy the property when the contract is up; however, you are not obliged to do so. If you decide against buying, the option simply expires.
  • Purchase option: you are legally required to buy the property at the end of your lease.

Rent-to-Own vs. Normal Renting

Although “rent” is the keyword, there are a few differences between rent-to-own and regular renting to be aware of. For starters, the extra amount you pay each month allows you to invest in the property from the very beginning by building equity as well as saving for a down payment. Meanwhile, regular rentals provide you with a place to live, but the rent itself can hardly be considered an investment towards your future home.

There are also differences when it comes to your obligations as a tenant. Often, rent-to-own contracts will stipulate that it is your responsibility to repair and maintain the property, which is something that falls in the landlord’s court in the case of normal rent contracts.

Also, bear in mind that the upfront fees paid at the start of the rent-to-own contract are non-refundable, unlike the deposit paid with a regular rental. Whether you’re in a lease-option agreement or simply cannot buy the property at the end of the contract, the money will not be returned to you.

When Is Rent-to-Own a Good Idea?

Rent-to-own is an excellent choice if you’re looking to buy a home, but also looking to buy a bit more time. If you’re not yet financially ready, this type of agreement will give you time to reach the credit score needed to secure a mortgage, sort out your finances, as well as save for a down payment. Also, not only is part of your rent building up towards your down payment, but it also helps you build equity while you’re just a tenant.

Think of it as a middle ground between renting and buying, combining the perks of renting with the feeling of stability you get from knowing you’re one step closer to buying your dream home. Rent-to-own also acts as a test drive for the property itself, as well as the neighborhood, school district, local amenities, and so on.

So if you’ve already set your mind on a property that you like and simply need some time to tie financial loose ends, rent-to-own homes are very likely to work in your favor.

When Rent-to-Own Won’t Work for You

The main thing to note about rent-to-own agreements is that they often act as a forced savings plan. While this may work for some future homebuyers, others might find their finances strained as a result. By design, you will pay more each month than you would with a regular rental, so make sure that your budget can accommodate that.

There’s also more at stake with rent-to-own homes. Most contracts have harsh penalties in place for overdue rent, and late payments can void your agreement, losing you all the money already invested in the property. Not only that but if you’re in a lease-option agreement, remember that you will not be able to make a return on your investment.

Rent-to-own agreements have more in common with buying a house than renting, so it’s worth considering your long-term commitment to the property. You will have less flexibility than in the case of regular rentals, and although you can decide to relocate at the end of your lease, you will be forfeiting a hard-earned down payment. Also, if it turns out that the house and the neighborhood are not to your liking, then rent-to-own can be a costly test drive.

 

Disclaimer:
This article is intended for informational purposes only and should not be deemed as legal, financial or investment advice or solicitation of any kind. Before purchasing real estate or insurance, always consult with a licensed attorney, financial advisor, insurance agent and real estate broker.

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