Rent-to-own agreements have a bad reputation in the real estate industry, but is it deserved? Well, it depends. There are many different kinds of rent-to-own agreements, and each one can be modified and customized for the tenant and the landlord. Many rent-to-own agreements overwhelmingly favor the would-be seller of the property, the landlord, which is one reason why they have the reputation they do.
What do you need to know about rent-to-own agreements — and could it be worth it for you?
The rent-to-own basics
In a nutshell, the way rent-to-own works is that tenants agree to pay additional money in rent every month in exchange for the opportunity to buy the house. There are a couple of different ways these agreements can be structured, but they always boil down to above-market-level rent so that the tenant can start building some equity in the home.
This can be problematic simply on its surface. For tenants who struggle to save up enough money for a down payment, it might not be at all easy to spend several hundred dollars every month on top of their rent value. On the other hand, tenants who can’t manage to save a down payment might find that this is actually a better option — the money is going somewhere they can’t touch it, and when the time comes to buy the house, it’ll already be there waiting for them.
Lease option and lease purchase agreements
There are two essential types of rent-to-own agreements, a lease option agreement, and a lease-purchase agreement. Of the two, the lease-purchase agreement is more legally binding: If you sign one of these, you are obligated to buy the house when your tenancy is over. In a lease option agreement, however, you have the option to buy the home when your lease is up — but you are not required to.
These agreements will also include details about the home purchase. Sometimes a lease option or lease-purchase agreement will go so far as to state the sales price of the home when the tenant’s lease is up, either based on the home’s current market value or calculated as a projected value. But other agreements specify that the home purchase price will depend on the real estate market when the tenant is actually ready to buy.
In both of these lease agreements, the tenant is responsible for securing financing for the home purchase once the lease is up and the tenant is ready to buy. This means that if you sign a rent-to-own agreement and you aren’t able to get a mortgage loan when your lease is up, you may forfeit all of the extra money you paid throughout your tenancy.
The cons for buyers
There are a few big red flags that buyers should look for in any rent-to-own contract. And if you’re seriously considering buying a home like this, do lots of research on the seller. You don’t want to find yourself at the mercy of a shady person with unethical business practices because you were too excited to own a house to do any due diligence.
Buyers will have to pay an additional upfront fee for the opportunity to buy the house at a later date. Often called option money, this money might or might not apply to the equity in your home, and will almost definitely be lost if something happens and the deal falls through.
One thing that buyers need to think about is maintenance clauses. In many rent-to-own agreements, buyers are responsible for maintenance and repairs on the home during their tenancy. This might not be a big deal if you have to get a window air conditioning unit fixed, but what if there’s something wrong with your water heater or your sewer main? Or your fuse box? Those repairs can really add up, and you’re still not the owner, so you’re spending your own money to repair a house that you might not ever own.
Another clause to keep an eye on is the one that outlines under what conditions the agreement can be broken. Often, if the buyer is late with a single rent payment, they lose all of their investment. And if the landlord isn’t in good financial standing and forecloses on the house, the buyer loses all their money invested then, too.
This is why it’s important to research your landlord-seller. If they have a history of taking advantage of buyers, then you can probably find evidence of it. Ask them for references, and do your best to figure out what kind of person you’re doing business with. Lots of people who offer rent-to-own opportunities are ethical humans, but of course, there are always bad apples.
And, of course, if something happens with your job or your family, and you have to move out of the area, you’ll have to break the agreement and leave your home (and investment) behind.
The pros for buyers
Many clauses in a rent-to-own agreement are negotiable, which means you can ask for things, too! You can request that your option money go toward your equity in the home, for example, or for the seller to maintain the big systems in the house while you’re in charge of smaller wear-and-tear items. So one pro is that if you know your rights and you're willing to work with your landlord-seller, you can come up with an agreement that works well for both of you.
Another is that for buyers who want to own a home but aren’t quite financially ready, rent-to-own can really help you build equity and set yourself up to buy the house where you’re living in a couple of years.
A rent-to-own agreement isn’t for everyone. It can be more expensive than buying a home the traditional way over the long term, and if buyers have the ability to save up a down payment and jump through all the hoops, they will most likely get a better deal on a house that isn’t a rent-to-own. But if you’re in love with the house where you live and it’s worth it to get your foot on the homeownership ladder that much sooner, it might be something you should consider.