What Does Rent-to-Own Mean? The Step-by-Step Process, How it Works, and What to Look For Along The Way

Renting to own is a viable path to homeownership, no matter where you are—whether you're in an upstairs unit in a townhome in NYC, a condo in Charlotte, NC, or an apartment in Nashville. For those who dream of owning a home but struggle with securing a mortgage or saving up for a down payment, a rent-to-own agreement offers a practical alternative. This option combines the flexibility of renting with the opportunity to purchase, providing a step-by-step process to making homeownership a reality. 

However, it's essential to understand the intricacies of this agreement, as it involves more than just a standard lease. Taking the time to learn how rent-to-own works and what to watch for will help you navigate this process and determine if it's the right choice for you.

What does rent-to-own mean?

Rent-to-own, also known as a lease-to-own or lease-option agreement, is a contract that allows you to rent a home for a specific period with the option to buy it before the lease ends. This type of arrangement is often appealing to those who want to become homeowners but may not currently qualify for a mortgage or have sufficient savings for a down payment.

In a rent-to-own agreement, a portion of your monthly rent payment may go toward the eventual purchase of the property. The contract typically consists of two main parts: a standard lease agreement and an option to buy. During the lease period, you’ll live in the home as a tenant, but with the added benefit of working toward ownership.

However, it's important to note that rent-to-own agreements can vary greatly in their terms and conditions, and they often require a higher level of scrutiny than a traditional rental contract. Understanding these terms, including the purchase price, how much of your rent applies to the purchase, and the duration of the lease period, is crucial to making an informed decision.

Rent-to-own can be a beneficial path to homeownership, especially if you’re committed to buying but need time to improve your financial situation or credit score. But it’s not without risks, so it’s essential to go into the agreement fully informed and prepared.

How does rent-to-own work?

In a rent-to-own arrangement, renters pay a set amount each month as rent. Additionally, they pay a preset amount above the regular rent, which is allocated towards the future down payment on the home. This extra payment, often referred to as a rent credit or rent premium, is typically around 20 percent higher than the market rent.

Here’s an example: 

If the monthly rent is $1,000, a renter might pay an additional $250 each month towards the down payment. This setup can be seen as a form of forced savings, helping the renter accumulate funds for purchasing the home. It’s also common for the renter to make an upfront nonrefundable deposit, usually 3%-5% of the home's value, before moving in.

Rent-to-own agreements usually span one to three years, giving renters time to save up and prepare for eventual homeownership.

Types of rent to own agreements

Don't make the mistake of assuming that because legal jargon sounds the same, it means the same. There are two main types of rent-to-own agreements: lease-option and lease-purchase.

1. Lease-option agreement

In a lease-option agreement, you have the option, but not the obligation, to purchase the home at the end of the lease period. This type of agreement offers more flexibility because you can choose not to buy the property when the lease ends. However, if you decide not to buy, you typically forfeit any rent credits or option fees you've paid.

2. Lease-purchase agreement

A lease-purchase agreement, on the other hand, obligates you to buy the home at the end of the lease term. This type of agreement is more binding and usually comes with stricter terms. If you are unable or unwilling to purchase the home when the lease ends, you could face legal or financial penalties.

Understanding the differences between these two types of agreements is crucial before entering into a rent-to-own contract. A lease-option offers more flexibility but less certainty, while a lease-purchase provides a clear path to ownership but with more commitment.

Step-by-step process on how to rent-to-own

So you’re thinking about rent-to-own. How do you go about it? Here’s steps to buy a rent-to-own homes:

1. Research and find a property

Start by researching rent-to-own properties in your desired area. Look for homes that fit your needs and budget, and make sure to review the terms of the rent-to-own agreement carefully. Consider working with a real estate agent who has access to search resources and property networks that you don’t. They can help you find the right property while avoiding potential pitfalls.

2. Review the contract 

Before signing anything, thoroughly review the rent-to-own agreement. Pay close attention to the purchase price, rent credit, and any option fees. Make sure you understand all the terms and conditions, including what happens if you decide not to purchase the home or if you are unable to secure financing. A real estate agent can help negotiate a contract that is fair to both you and the seller.

3. Find a rent-to-own program 

Look into companies that offer rent-to-own programs. These companies can buy the home you’re interested in and lease it to you for a set period. After that, you have the option to purchase the home. One of the most well-known such companies is Home Partners of America, which doesn't even require the renter to build equity during the process. 

4. Move in and make payments 

Once the agreement is signed, you can move into the home and start making your monthly rent payments, along with any additional rent credits. Keep track of all payments and make sure you stay on top of any repairs or maintenance, as these responsibilities are often shared in a rent-to-own agreement. If you’re currently renting a home you love, consider approaching your landlord about a rent-to-own arrangement; they might be open to selling in the future.

5. Exercise your option to buy 

As the lease period comes to an end, decide whether you want to exercise your option to purchase the home. If you choose to buy, work with a lender to secure your mortgage and finalize the purchase. If you decide not to buy, be aware that you may lose any option fees and rent credits you've paid.

Tips and things to remember before you rent-to-own

Whether you use an agent or not, denote in the contract if the landlord or the tenant (you) is responsible for home maintenance, repairs, landscaping, homeowners association dues, property taxes, and so on. Failure to do so could cause some nasty and expensive surprises.

Also, complete a thorough home inspection before you sign the contract. No one wants to rent to own a home with a major foundation or other pricey problem. While you're at it, check out the seller's disclosure to find out about any hidden past problems.

Lastly, make sure to discuss your situation with a future lender. You'll need to be able to afford the home in one to three years. Are you on the right path? If not, what needs to change?

Pros and cons of renting-to-own

Pros

• A rent-to-own agreement with a rent credit forces the renter to put away money. This concept of "rent to own" means that a portion of your rent goes toward eventually purchasing the property. Saving for the future is a good thing.
• Rent-to-own agreements are a great way to break into a desirable area.
• The purchase price is typically set at the beginning of the agreement, so this could be great if the market explodes.
• A contract leaves little doubt as to who's on the hook for what.

Cons

• If a renter chooses not to purchase the home they forfeit rent credit money (and any deposit).
• Many rent-to-own homes are not located in such desirable areas, so it might take extra legwork and patience to find one.
• The market could also tank, leaving you to weigh whether to pay more than the current value of the home or not.
• Be sure to follow your contract to a “t," so that you don't wind up losing a deposit or get fined.

 

The information contained in this article is for educational purposes only and does not, and is not intended to, constitute legal or financial advice. Readers are encouraged to seek professional legal or financial advice as they may deem it necessary.

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