Rent-To-Own Homes: How the Process Works

What are rent-to-own homes?

A rent-to-own home is a property that a seller is willing to lease before selling. The buyer and seller agree to establish a rent-to-own contract in which the buyer will pay a set amount of rent for a period of time, typically one to five years. At the end of this contract, the seller agrees to sell you the home at the agreed-upon costs.

How rent-to-own homes work

The traditional mortgage process involves securing a mortgage loan from a financial institution, making a down payment and purchasing a property outright. With a rent-to-own contract, you don’t need to meet strict lender requirements or have a large down payment right away.

Unlike a traditional rental agreement, RTO contracts give the buyer the right to purchase the property before or at the end of the lease for the agreed-upon amount. With traditional renting, your monthly payments don’t count as a down payment, and the property owner can sell or change the rental agreement within their legal rights.

Lease option vs. lease purchase

With a rent-to-own contract, there are two options: lease option and lease purchase option.

• Lease option: This option is more flexible since it allows buyers to change their minds at the end of the contract. You’re not obligated to purchase the home at the end of the lease option, though you will lose any extra fees you paid toward it.
• Lease purchase: In a lease purchase contract, you could be legally bound to purchase the home at the end of the lease, even if you can’t afford it.

» MORE: Renting vs. buying a house

Who is a rent-to-own home best for?

Steve Nicastro, a former real estate agent and current managing editor for Clever Real Estate, an online agent-matching service, said RTO is a suitable option for the following types of buyers:

• Prospective buyers who have a detailed plan in place to improve their credit score and finances
• People who need time to save up for a down payment to buy a home but can afford the monthly payments of an RTO contract
• Individuals or families who know they want to live in a specific house, neighborhood and city

While the rent-to-own option can be more pricey than the traditional mortgage path, it also provides a solution for those who don’t meet conventional lender requirements.

“RTO homes are a big commitment and can be very expensive, so you should be certain that that's where you want to stay for the long term,” Nicastro said. “You should avoid them if you anticipate moving in a few years or have an uncertain job situation that may require a relocation.”

Pros and cons of rent-to-own agreements

Consider the pros and cons before moving forward with your decision to rent to own.

How to get a rent-to-own house

Entering into a rent-to-own agreement is a legally binding contract between the landlord/owner and tenant/potential buyer. It’s important to be thorough in the process to avoid legal issues later on.

1. Decide if you want to work with a real estate agent

While a real estate agent isn’t necessary for an RTO home, they can help contact and find owners willing to enter an RTO agreement.

2. Find eligible RTO homes

There are a few real estate sites that specialize in RTO listings which can make it easier to find willing owners in your area. RTO listings are also typically posted on social media sites, Zillow and Craigslist. You can also contact property owners or landlords of existing rentals or properties that have been for sale for over six months to inquire about the possibility of an RTO agreement.

Just keep in mind that it may be harder to find RTO homes, so it may take some time to search for options.

“The RTO homes market is very small compared to traditional listings and rental properties,” Steve Nicastro said. “I believe it makes up less than 5% of the total market.”

3. Negotiate lease terms and purchase option

If the owner agrees to an RTO agreement, discuss and negotiate the lease terms, including the duration of the lease, rent amount and the purchase option price and terms. At this time, you should order an appraisal and inspection to ensure you know the value of the home and if there are any potential and costly problems.

» MORE: Homebuying checklist

4. Consult an attorney

Consult with a real estate attorney to review the rent-to-own agreement and ensure your interests are protected. Rent-to-own agreements are not all the same and can be full of tricky legalese intended to trap the buyer. A real estate attorney can help protect you and your finances by ensuring you understand exactly what you’re agreeing to.

5. Execute the agreement

Once all parties have agreed upon the terms, sign the rent-to-own agreement and fulfill any upfront fees or down payment requirements. Notarizing these contracts isn't required, but it can be a helpful layer of protection.

Rent-to-own home costs

Rent-to-own costs might appear less expensive upfront, but the whole process can cost you more than a traditional mortgage. Typically, tenants are responsible for any home maintenance or repairs once they enter the contract, even though they’re not considered the legal owners yet.

Other fees can include:

• Option fee: This is a one-time, nonrefundable fee of 1% to 5% of the home value paid upfront.
• Termination fee: This fee could cost you 1% to 2% of the home value if you terminate the contract.
• Inspection and appraisal fee: These fees typically range from $200 to $600, depending on where you live.

Alternatives to rent-to-own homes

If you’re interested in buying a home but unable to qualify for a loan, there are some alternative options you may want to consider.

First-time homebuyer programs

Many states, counties and nonprofits offer first-time homebuyer programs, allowing prospective homebuyers to get assistance with financing, down payments or closing costs. Programs are typically in the form of a grant or a loan, and they typically have lenient credit and income requirements.

Government-backed home loans

Government-backed home loans like Federal Housing Administration (FHA), U.S. Department of Agriculture (USDA) and U.S. Department of Veterans Affairs (VA) loans are designed for low- to moderate-income borrowers. They all have low or no down payment and credit score requirements, making them a great option to consider.

Choosing a cheaper rental temporarily

If your credit history isn’t in good shape, or if you don’t qualify for homebuying assistance or government-backed loans, you’ll likely need to focus on building your credit and savings first. Renting a cheaper apartment temporarily can save you money and allow you to focus on getting your finances in good shape to qualify for a home loan or even a rent-to-own agreement down the line. If you need help, consider using a credit counseling service.

Bottom line

Rent-to-own agreements can be a good solution for buyers who need a house-buying alternative due to finances or creditworthiness. These agreements allow tenants to test properties and neighborhoods before making a long-term commitment.

However, these agreements have some downsides, such as higher costs or initially limited control of the property. Even if renting-to-own is right for you, it's best to approach RTO agreements with careful consideration and seek guidance from an experienced real estate agent or real estate attorney.