Rent-to-Own Homes: How Does It Work?

Before qualifying for a mortgage, you'll need to maintain an acceptable credit score while saving for a down payment. Real estate commissions, appraisal fees and title searches, standard mortgages and their associated costs might deter you from starting your homebuying journey. 

Renting a place can feel like money every month going nowhere toward achieving your goals. However, deciding whether to  might not be as binary as it seems. You could buy some time to strengthen your finances while getting started on homeownership with a rent-to-own home. 

If you’re ready to explore how much home you can afford, apply now! 

How does rent-to-own work? 

Rent-to-own homes allow you to rent a property before deciding to buy. You’ll get more time and flexibility to improve your finances leading up to applying for a mortgage. 

A standard rental agreement requires you to make payments, usually monthly, throughout the term of the lease. For some rent-to-own properties, some of the payment could go toward a down payment for the purchase of the home. 

That portion of payments, called rent credits, is written into the contract between the buyer and the seller. Market trends and the seller's eagerness to complete the sale will help determine how much will go toward the down payment each month. 

Before you buy the property, you will have had time to bring up your credit score and build finances for the . 

At the end of the rental period, you’ll use the rent credits to take an ownership stake in the home. The remainder of the home’s cost could be covered by a lender through a mortgage loan. 

Types of rent-to-own contracts 

Two common rent-to-own agreements differ in that one could allow you to opt out of buying the home at the end. The other may legally obligate you to purchase the home. 

Lease-option agreement 

Rent-to-own properties with a lease-option agreement allow you to buy the home when the lease is up but won’t obligate you to purchase the property. 

When signing a lease-option agreement, you’ll pay the homeowner an upfront cost called an option fee. 

Usually 1%-5% of the home’s sale price, an option fee secures your right to purchase the home after an established period of time. Option fees prevent the seller from accepting an offer on the home while ensuring your right to make the initial bid. 

These fees are usually negotiable and can be worked into the home’s eventual sale price. Option fees might be nonrefundable if you decline to buy the property depending on the terms of your agreement. 

To buy the home, you and the seller would need to negotiate a price. An  can help determine the home’s value. 

Lease-purchase agreement 

Much like a lease-option agreement, lease-purchase agreements involve renting a property for an established period of time. However, lease-purchase agreements settle on a sale price when the agreement is signed rather than at the end of the term. 

In a lease-purchase agreement, you are responsible for funding the purchase of the home. That means securing a home loan before the lease term ends. You established the purchase price when signing the contract, so you could start shopping for lenders as soon as you start renting. 

Home prices generally go up, so locking in a sale price could also help save thousands in the long term. You’ll be able to purchase the property at the price that was established when you moved in.* 

Pros and cons of rent to own homes 

Pros 

If the immediate costs of buying a home are preventing you from , renting to own might be a good option. While these agreements include some upfront costs, they are generally not as steep as those associated with buying a home. During the rental period, you’ll have time to put money toward the purchase while saving for the costs of eventually closing the sale. 

Rent-to-own agreements don’t require mortgage approval right away. When approved for that mortgage, the previous owner hands over the deed as the lender places a , using it as collateral to ensure repayment of the loan. 

Cons 

Changing economic conditions, damage to the property or payments missed by the buyer could alter the outcome of rent-to-own contracts. Because the benefits of these agreements depend on some external factors, the terms of rent-to-own contracts can vary widely. 

So, what if the lease ends and you decide not to buy the home? Depending on your contract, opting out of the purchase might not be allowed, and you could lose the money you’ve put toward the purchase.  

Who should consider rent-to-own homes? 

If you’re just starting life as an adult, renting likely will be your most reasonable option. After all, you need time to , save money for a down payment and get serious about making . A rent-to-own option could be worthwhile since you’ll put some of your monthly rent payment toward homeownership, an option you don’t normally get with a regular rental agreement. 

A rent-to-own option could also be useful for a potential homebuyer with credit challenges. This type of lease agreement could give you time to clear up any credit issues, save for when the lease ends and buy the home you’ve already been living in. 

How to buy a rent-to-own home 

To explore whether renting to own might be a good option for your financial situation, learn more about  and what they reveal about your eligibility for a mortgage. 

It’s also a good idea to consult a real estate attorney who can help you understand the terms of the agreement you plan to sign. 

Mortgage experts at Rate can help you with your home loan once you are ready to apply. If you are ready to explore your home buying options, apply now! 

^{*Savings, if any, vary based on consumer’s credit profile, interest rate availability, and other factors. Restrictions apply.}