How Does Rent to Own Work? 2 Types of Rent-to-Own Contracts

In the real estate market, rent-to-own properties have an agreement allowing residents to buy a home after renting it for a set period. In this purchase contract, residents will submit monthly installments during the rental period, paying a little over the market value, so the extra money becomes the down payment at the end of the lease.

This method works for buyers who may not have good credit scores or the ability to pay the upfront cost of a down payment. Sometimes, renters also have to pay an option fee of about five percent of the home’s value to hold the ability to buy the house. Deciding to enter a rent-to-own contract must be a highly deliberate decision because if you do not buy the home at the end of the lease period, you will lose those extra payments.

Rent to own is a reasonably straightforward process and a helpful path toward homeownership, particularly for prospective homebuyers without solid credit history or the ability to afford the upfront fee of a down payment.

In rent-to-own agreements, tenants pay monthly rent payments with a portion of the rent going toward the home's down payment. The monthly payment will be slightly above market rent; this covers the home's rent with the extra money deposited toward the down payment. At the end of the lease term, tenants can become homeowners by making a home purchase with the prepaid funds and then beginning monthly mortgage payments. Now, as homeowners, the residents will build equity and can be more competitive candidates for the future in the housing market.

Lease-option and lease-purchase agreements are the two main kinds of rent-to-own contracts:

1. 1. Lease-option agreement: Lease-option contracts require an option fee, where renters pay the current homeowner an option fee of anywhere from two to seven percent of the purchase price of the home. This reserves the renter the option to buy the home at the conclusion of the lease, at which point the renter and homeowner can agree on a fair purchase price. Typically, an appraiser will assess the home's value; the renter can buy or not, but if they don’t, they lose their rent credits and option fee.
2. 2. Lease-purchase agreement: Rent-purchase contracts are similar to lease-option ones—renters still put aside money with each rent payment to go toward the home—except, in this agreement, the renter has to buy the home after the lease period ends. Typically, the initial lease includes the purchase price. This type of agreement obligates the renter to purchase the home, and not doing so can lead to a lawsuit.

There are some benefits to this path toward homeownership. Advantages include the ability to:

1. 1. Build up funds for a down payment. Putting some extra cash aside with each rent payment helps you save money for your down payment, making you a trusted and viable candidate for buying the home.
2. 2. Weigh options. Except in lease-purchase agreements, rent to buy allows residents the option to stay and buy the home or leave and find another. Renting over a period of time lets you feel out the house, neighborhood, and commute to see if you like it—just note that you don’t get any of your fees or rent back if you choose to leave.
3. 3. Save on repair costs. Usually, homeowners and renters split any maintenance or repair costs that go toward the house during your time as a renter on a lease. That can help you save money while showing what kind of shape the house is in and what you may expect to pay to tend to it in the future. Be sure the contract clearly outlines the maintenance responsibilities.
   

Rent to own can also be a tricky housing agreement if you are unfamiliar with the arrangement. Consider the following:

1. 1. You could lose money. If you choose not to buy the home at the end of your lease, you will lose the money you invested in it via option fees, rent payments, and any maintenance you put into it.
2. 2. You might have to buy the house. In a lease-purchase agreement, you are locked into buying the house after the lease is over. Over those couple of years, the economy and the housing market can shift, meaning a decision you made before signing the contract may not be the one you would have made in hindsight.
3. 3. There’s more pressure to stay financially stable. If you are in a position where you cannot make consistent rent payments, you damage not only your reputation but also your chances of buying the home at the end of the lease as the set-aside money goes toward a down payment.

All investments, including real estate investments, come with inherent risks which may involve the depreciation of assets, financial losses, or legal ramifications. The information in this article is for educational, informational, and referential purposes only. Consult a licensed real estate or financial professional before making any legal or financial commitments.

MasterClass at Work is the learning platform to help unlock the full potential of your employees and inspire a learning lifestyle in everyone. From negotiation to mindfulness to baking—these are just a few things your teams can explore.