How do rent to own homes work?
In some ways, renting to own is like getting a conventional mortgage, but with some key differences.
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 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. Ownership of the property doesn't officially transfer to you until you pay off the purchase price for the house.
Rent to own homes pros and cons
One of the most significant downsides of renting to own is that it can cost a lot more than purchasing a home conventionally. For one thing, when you negotiate a rent-to-own, 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 amount each month toward the purchase price, and the interest rate is usually higher.
Another big concern when renting to own is that if you default, you can be evicted just like any other tenant. If that happens, you may lose any money you've paid up to that point towards the home's purchase price.
The last concern to renting to own is exposing yourself to risk that you can't always control. For example, if you sign a rent-to-own agreement and the seller of your home gets sued, the creditor could place a lien on your home, which could cloud the title and make it difficult for you to purchase later.
Insuring a rent-to-own home
Because you are considered a renter when renting-to-own, you'll qualify for renters insurance instead of homeowners. Once you pay off the house and the title transfers to you, you'll need to switch to a traditional homeowners insurance policy. Learn more about how renters insurance works.