What are lease-to-own or rent-to-own homes?

If you find a home you love but might not qualify for a mortgage right now, lease-to-own or rent-to-own options allow you to spread out the purchase process over months or years.

Both the buyer and seller sign a rent-to-own contract stipulating how much of the buyer's monthly rent payments will be put toward eventual equity in the home.

While that may sound great, it’s not as tidy as a traditional sale. Everything is up for negotiation: purchase price, down payments, closing costs. It can get convoluted as you try to come to terms on all aspects of the sale.

And there are no standard contracts for this approach. With completely negotiable terms and fewer regulations compared to straightforward buying or renting, buyers face a lot more risk with this set up.

If this is something you’re considering, you should seek out qualified professionals like a real estate agent and an attorney to go over the agreement before you sign anything.

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How do lease-to-own homes work?

When you find a home that’s listed as lease-to-own, you’ll start out renting from the property company or individual who owns the property.

There are two different types of agreements you might enter into: a lease option agreement or a lease purchase agreement.

The option agreement allows you to decide if you want to go forward with purchasing the home once the rental term has ended. And with a purchase agreement, you’re legally required to go through with the sale.

With so many variables involved, agreements vary widely in structure and content, but they contain the same basic components:

Purchase price

Entering into a lease-to-own agreement, you won’t always know how much you’ll have to pay for the home. Sometimes the price becomes official when you sign the contract, but other times it’s decided only once the lease term expires.

The price can be based on the value of the home when you enter into the deal, or what the seller anticipates the house's value will be down the road.

Rent payments

The contract will lay down how much you'll pay in rent every month.

You’ll find the home is generally more expensive than other rentals in the area because part of the payment is being credited towards your future purchase of the house.

Maintenance

While you’re renting, the seller may ask you to be responsible for any regular costs associated the home, including maintenance and repairs. You may also have to cover homeowner’s association (HOA) fees and property taxes.

Make sure you clearly read the contract and understand exactly what you’re responsible for while you’re still renting.

Option money

This mandatory one-time, non-refundable fee is what grants you the opportunity to buy the house. Some sellers will agree to put this sum towards your equity in the home, but it’s up to them. How much you’ll pay is generally based on a set percentage of the value of the home.

Lease term

The lease term, or how long you’ll rent the home, will be written into your contract. If this term ends and you can't qualify for financing or decide you don’t want to buy the home afterall, the option to buy will expire.

Closing process

Once the lease term ends, if you plan to purchase the house, you’ll need to secure financing. After you’ve been approved, your mortgage lender will set the closing date and after that, the ownership will then be transferred over to you.

Whatever was set aside for your purchase will then be credited to your loan.

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Is rent-to-own worth it?

While it sounds great, and you’ve got the insurance of a contract, it doesn’t take much for a rent-to-own situation to go sideways.

Let’s go over the pros and cons of this approach.

Pros

The positives of this approach are pretty clear: you can chip away at offering a down payment over time, rather than having to have it in cash upfront. And your down payment installments are also building equity in the home before you’re the official owner.

Lease-to-buy also gives you a little more time to get your finances in order to qualify for a mortgage. If your credit score needs improvement or you still have some debt to get in order, you can work on improving your qualifications while living in the home you plan to buy.

If you live in a hot housing market, having this type of contract will also take competition out of the equation. You won’t find yourself competing with other potential buyers, which can drive up the purchase price significantly as well.

Cons

If you’re already in a precarious financial position, a lease-to-own agreement isn’t likely to make it better. First off, your rent will be significantly more expensive than if you were in a simple rental agreement.

Your landlord or property owner isn’t required to put your option money towards the down payment. They can decide to keep it for themselves, leaving you out a chunk of change.

And if you need to move or decide not to buy the home after the rental term ends, you’ll be walking away with less than nothing—as you’ll lose all the money you invested in the home’s equity.

These contracts also tend to favor the seller. At any point, the seller can cancel the contract for any small infraction or violation and you have no recourse.

Or the seller could simply change their mind at any point. Going to court to force them to follow through on the deal can be expensive and there’s no guarantee it will work anyway.

You may find also yourself on the hook for any repairs and maintenance that come up while still renting. And since you’re not yet an owner in the home, you wouldn’t qualify for a home equity loan or line of credit to help you cover the costs.

Or the home’s value could decrease. If you agree to a set price when you sign the contract and the home isn’t worth it by the time you’re prepared to buy, it may be hard to find a mortgage lender willing to loan you more than the house is worth.

Finally, if anything happens with the actual owner’s financial situation and there is a lien placed on the home or it goes into foreclosure, you’ll lose your rights to the property.

Alternatives to lease-to-own homes

Given all the risk on the buyer’s end, rent-to-own may not be the right approach for most aspiring home buyers.

Saving up for a down payment is often the most challenging part of buying a home. The appeal of having part of your rent contributing to that goal makes sense. But you pay extra for that.

When you think about it, why wouldn’t you just put aside the extra money you’d pay to save up for a down payment instead? And with it in your own bank account, you’d get to decide for yourself how to invest it.

If your finances need straightening out, the best option for you would be to stay in a rental you can afford and continue to chip away at your debts. When you’re back in the black, then you can put aside the funds you’ll need to buy a home.

Next steps

Wanting to buy a home is a central part of the American dream. While rent-to-own may not be the best way to get you there, it’s not the only option.

There are a number of mortgage loan programs for low to moderate income households that make buying a home more affordable. Backed by the federal government, FHA, USDA and VA loans help specific demographics attain the dream of homeownership.

And for first-time homebuyers your state may also have programs to help residents purchase a home. With favorable interest rates and down payment assistance, these programs cancel out the need for options like rent-to-own.

Take some time to explore the options available to you as a prospective homebuyer. You may find, with a little help, you’re closer to fulfilling your dream than you’d originally thought.

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About the Author

Sigrid Forberg

Sigrid Forberg

Staff Writer

Sigrid is a staff writer with MoneyWise. A graduate of Carleton University's journalism program, she spent the better part of the last six years writing about business and retail. In her spare time, she enjoys reading, baking and riding her bicycle.

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