You can buy a home or you can rent a home. But there’s a third option you might not have considered. Renting to own can buy you time to save up for a down payment while keeping you in the front of the line of potential buyers when it’s time to purchase. Maybe you’re not sure you can qualify for a mortgage just yet. Maybe you know you want to move, but you just aren’t sure about a home purchase, and the idea of a short-term rental sends you into alternating fits of dreams and nightmares. If this sounds like your situation, renting to own might be a viable solution. We’ve assembled this list of rent-to-own pros and cons to help you make a careful, better-informed decision about what could be your most significant investment ever.
How does it work?
A rent-to-own contract is an option for people who know they want to buy a home but aren’t quite ready to buy just yet, giving them time to save and improve credit while securing a home for eventual purchase. They typically work in one of two ways: lease purchase and lease option. First, the seller establishes a term, usually one to three years. At the end of the term, the resident is either required to purchase the home (lease purchase) or has the option to make the purchase or walk away (lease option). Sometimes, both agreements will allow for an extension of the rental period prior to a deal. It’s generally a bad idea to sign a lease-purchase agreement unless you’re sure you want the home, you’ve had it inspected, and you’re financially secure enough to be sure you’ll be able to afford the mortgage at the end of the term. Sometimes, a specified part of your monthly payment goes toward your eventual purchase price.
Rent-to-own versus a mortgage
If you don’t have enough money for a down payment on a traditional mortgage (typically 20%), or you don’t have a credit score of at least 629 or so, you might need time to save money and improve your credit. Meanwhile, if you’ve found a home that you’re excited about, and if renting to own is an option the seller is willing to entertain, you could have the potential for a mutually beneficial agreement. You’ll have time to lower your debt-to-income ratio, keeping your interest rate down, and the seller will have a guaranteed sale (if it’s a lease-purchase agreement). A more flexible seller might like the idea of a long-term renter enough to even go for a lease-option agreement. Still, get advice from a real estate agent, lender and lawyer.
Credit implications
Rental payments aren’t usually reported to credit bureaus. However, if you’re trying to improve your score, and the seller agrees, you can arrange to have your payments reported so they will impact your credit rating. Make sure to keep track of all your payments, and get them in on time or early. Look at improving your credit during the term as your mission (or second job).
Key terms and definitions
- Purchase price: Your rent-to-own contract will set a purchase price, which could be more than the current market value, giving the seller an incentive to wait years from now to sell.
- Rent credit: Typically nonrefundable, this is the portion of your monthly rent that is contractually credited to the final sale when you complete the purchase years later.
- Term (or time) limit: Most rent-to-own agreements last between one and three years, but both parties can agree upon and contractually specify any amount of time.
- Renewal stipulation: The contract should make clear whether and how the buyer/rent-to-owner has the option to extend the agreement if necessary and for how long.
- Option fee (or consideration): Also known as a premium payment, this locks a future purchase price into place and gives the tenant the first purchase option at a future date.
- Maintenance clause: Based on an overall spending cap or spelled out on a line-item basis, this clause explains who is financially responsible for maintenance costs.
- Lease option: This type of contract includes no legal requirement to buy but retains the option for the tenant, who can decide not to buy and leave after the lease ends.
- Lease purchase: This type of contract includes a legal obligation to buy at the end of the lease term. In this case, changing your mind could land you in court with the seller.
- Home warranties: If you’re wondering whether landlords must have a home warranty covering the tenant of a rental or rent-to-own contract, here’s a post on the possibilities.
Rent-to-own pros
- Fewer moves: With the right rent-to-own contract, you can avoid moving three times in three years, when traditional yearlong rental agreements expire.
- Build credit: If your credit isn’t quite where it needs to be, a year (or two or three) could be the time you need to improve it for the purchase.
- Help with the down payment: Renting to own can lower your initial down payment from 20% to as low as 3% or less, depending on the deal, which can help significantly.
- Flexibility: Some rent-to-own contracts do not require a purchase at the end of the term but still give you the first option, so you know you’ll have first dibs on that decision.
- Get your foot in the door: Renting to own can help you secure the home you already know you want, even if you’re not ready to buy, while helping you weather future price spikes.
- Credit flexibility: With bad credit, getting a rent-to-own contract is easier than a traditional mortgage, so you’ll have time to rebuild your credit rating over the term.
- Build equity: Sellers can configure the contract to apply an agreed-upon percentage of your monthly rent payments into the eventual purchase price or down payment.
- Locked-in price: The housing market fluctuates wildly, but you’ll have peace of mind knowing your eventual purchase price will not change over the term.
- Try before you buy: Maybe you often change your mind after a purchase. Maybe you’re not sure about the home. Need some time living there to decide? Consider a lease option.
Rent-to-own cons
- Losing money: You will lose your premium payment and rent credits toward the purchase if you decide not to buy at the end of the term, even while retaining the option.
- Scams: Beware of scammers, and always rely on professional advice. Don’t give up personal information initially, and a refusal of an inspection is a major red flag.
- Problems: If previously undisclosed liens or foreclosures arise, these could cause problems for your deal, which is why it is vital to get help from a good lawyer and real estate agent.
- High rent: Realize that your rent will be higher than the market average, although you will be putting some of it toward the purchase. Still, this will make budgeting tighter.
- Locked-in price: Yep, this could also work to your disadvantage. If the market drops, you’re still locked into a (now higher) price, which could also impact appraisal.
- Late payments: If you make late payments, you could put everything at risk, allowing the seller to back out of the agreement entirely. Read and understand every detail.
- Risks: Nothing is guaranteed. You’ll still have to qualify for a mortgage at the end of the term. If the owner defaults on the loan before that, you could be forced to leave.
- Fees: Though they’re sometimes applied to your down payment if and when you make the purchase, some contracts require nonrefundable fees paid upfront.
- Repairs: You could be on the hook for repairs unless your contract specifies that the seller will cover them throughout the term. Know your contract!
Best practices
Begin by obtaining a reputable real estate agent, lender and lawyer that you trust to help you review contracts. Make sure you have all your seller’s disclosures, including insurance claims and title information. Always insist on a complete home inspection from a professional.
In conclusion
We hope we’ve made some sense of typical rent-to-own pros and cons, at least enough to help you wrap your head around this option. While you’re at it, you might also want to know a thing or two about home warranties. Don’t forget, our vast catalog of free posts on all sorts of DIY home ownership, improvement, maintenance and upkeep concerns is here for you anytime.
The information in this article is intended to provide guidance on the proper maintenance and care of systems and appliances in the home. Not all of the topics mentioned are covered by our home warranty or maintenance plans. Please review your home warranty contract carefully to understand your coverage.