A rent-to-own agreement is a contract where you agree to rent a home for a specified time. Then, you have the option to buy it.
What’s a rent-to-own home?
A rent-to-own agreement is an alternative to the traditional process of purchasing a home.
Related: What’s earnest money?
In the contract, you agree to rent a home for a specified time period with the option to purchase it before the lease expires.
In some cases, a portion of your rent will go towards the down payment for the home. The details are negotiated with the company or individual who owns the property.
While the rent-to-own model sounds enticing, it can be risky. Learn how the process works and what to look out for.
How it works
While the details of every situation are unique, the following are the two types of rent-to-own agreements:
- Lease option. At the end of your lease, you have the option to purchase the home.
- Lease purchase. You’re legally obligated to purchase the home at the end of the lease.
In most cases, a lease-option agreement is better because you have a choice. If you sign a lease-purchase agreement, you must purchase the home after the lease ends regardless of your financial situation.
In both types of agreements, several details are important to cover. They’re as follows:
- Lease term. You’ll work with the seller to agree on a lease term.
- Purchase price. Agree on a purchase price, which is typically more than it’s currently worth due to increased future value. Sometimes the price is determined when the lease ends.
- Rent payments. You’ll have a set rent amount. You can work with the seller to have a portion of it applied to the purchase price.
- Home maintenance. Either you or the seller will be responsible for maintenance and paying for repairs.
- Option fee. Most sellers will require you to pay an option fee because they’re reserving it for you to have the option to buy the home after your lease. Typically, it’s 1% of the purchase price, and it’s a one-time, non-refundable fee.
It’s important to get another perspective, so review the agreement with a real estate attorney before signing the contract.
As you near the end of your lease, you’ll need the funds to purchase the home or secure financing.
If you’re getting a mortgage, you’ll have a closing date. That’s the day that the home will become yours.
If you want to buy a home in the next year or two and aren’t financially ready at the moment, you’d be a great candidate for the rent-to-own model. It gives you time to build your down payment.
It’s also a great option if you’re credit isn’t high enough to get approved for a good rate on a mortgage because it gives you time to build your credit score.
A rent-to-own contract also ensures that you don’t have to worry about competition. Since you have the option or obligation to purchase the home, other buyers can’t outbid you.
From a buyer’s point of view, there are several downsides. Often, you’ll pay more than the home is worth because you’re getting the choice to purchase the home. If the value of the home goes down, you’re also losing money there.
You may also be subject to a one-time option fee, which is the extra money that you’re forfeiting.
From a seller’s perspective, the rent-to-own model may be a good option if you’re having a difficult time selling your home.
You can also ask for a higher purchase price, which can lead to more money in your pocket.
If a renter has agreed to the contract, you’ll also have a more invested renter. This means the property will likely be taken better care of.
A rent-to-own agreement can be a great way for aspiring homeowners to work their way up to their goals. If you’re interested in getting a rent-to-own lease, look for a lease option, which gives you the choice and not the obligation to purchase the home.
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About David Em
David Em is the founder of More Money More Choices, which he launched to help you take control of your finances and build your dream life. Before More Money More Choices, David worked in leadership positions in the finance industry.