How does rent to own work?
Rent-to-own, also called renting with an option to buy, is a way to buy a home without going through a bank for a conventional mortgage. Instead, you finance the purchase directly through the homeowner. A rent-to-own agreement typically includes the purchase price, the monthly rent, and the schedule and term of payments.
What is rent to own a home?
In some ways, renting to own a home is similar to getting a conventional mortgage, but with some key differences. A rent-to-own arrangement can generally work one of two ways: a lease-purchase contract, which is a contract that allows renters to lease a property with an option to buy it later, or a lease option contract which stipulates that the renter can purchase the property at the end of the lease term for a specific price.
The tenant pays a fee for the lease option, which is typically a percentage of the purchase price. With a lease-purchase contract, the renter pays a higher than market rent, with a portion of that payment going towards the purchase of the property.
Steps to renting to own a home
You will take the following steps if you want to rent to own a home.
Negotiate a price
The first step in renting to own a home is negotiating a price. A rent-to-own deal has three components: the price for the home, the upfront fee for your right to buy the house (an option fee), and the monthly rent, along with what portion of the rent will go against the purchase price.
Sign the contract
Once you agree on the terms of the deal with the seller, you'll sign a contract on the property.
Move in as a tenant
When you sign a contract to rent to own a home, you become a tenant in that property (like a typical rental agreement). Also, like a standard lease, the title to the property stays with the seller. You have a right to acquire the house for a specific price on or before a certain date.
Apply payments towards your purchase
After you move in and start paying rent, a portion of your rent goes towards the principal that you owe on the house, similar to a mortgage. The big difference is that when you get a mortgage to buy a house, the title transfers to you, and the lender takes a lien against the property. If you later default on your mortgage payments, the lender can foreclose on your property. However, the title stays with the seller when you rent to own. Property ownership officially transfers to you once you pay off the purchase price for the house. Learn what to consider when buying a second home.
Pros and cons for rent-to-own homes
There are advantages and disadvantages to how rent-to-own works:
Rent-to-own allows renters with lower credit scores or limited savings to become homeowners
It provides a chance to live in the property before committing to purchasing it
The renter can lock in the purchase price at the start of the lease, which can benefit the buyer if the property appreciates
It allows renters to save up a down payment during the lease period
It costs much more than purchasing a home conventionally. You'll usually have to pay a fee upfront, called an option fee, in exchange for your right to purchase the house later
You'll pay an additional monthly amount toward the purchase price, and the interest rate is often higher
If you default, you can be evicted just like any other tenant and may lose any money you've paid toward the home's purchase price.
You may face risks outside of your control. For example, if you sign a rent-to-own agreement and the seller gets sued, the creditor could place a lien on your home, clouding the title and making it difficult for you to purchase later
If the property depreciates, you may pay more than the property is worth
If you're negotiating a rent-to-own, you may want to discuss insurance specifically with the seller. You'll want to make sure they have adequate coverage on the property and, depending on how your contract is structured, have them potentially add you as an additional insured on their policy.
Insuring a rent-to-own home
Because you will be a renter when renting to own, a renters insurance policy will apply instead of homeowners. Get a better idea about how renters insurance works, and discover the difference between renters and homeowners insurance.