Rent-to-own homes: how the process works

The higher costs might be worth the more flexible requirements

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Buying a house outright isn’t the only way to become a homeowner. Potential homebuyers are turning to the alternative rent-to-own (RTO) method to make their homeownership dreams a reality. While rent-to-own homes benefit buyers who don’t have excellent credit or a huge down payment, it can also be a risk if they don’t know what to look for when entering an RTO contract.

Here’s how rent-to-own houses work and what potential buyers should be aware of before signing up.


Key insights

  • Rent-to-own homes allow individuals to lease a property with the option to purchase it before the lease expires.
  • Rent-to-own agreements allow renters to build up their credit before buying.
  • Buyers seeking this alternative path to homeownership should be aware of higher costs and the risk of losing any upfront fees and rental credits.

What are rent-to-own homes?

A rent-to-own home is one a seller is willing to lease before selling. To enter a rent-to-own agreement, the buyer and seller agree to enter a contract in which the seller will pay a set amount of rent for a duration – typically one to five years. At the end of this contract, the seller agrees to sell you the home at the agreed-upon costs.

The traditional mortgage process involves securing a mortgage loan from a financial institution, making a down payment and purchasing the 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.

The lease option is a more flexible contract that allows buyers to change their minds at the end of the contract. You’re not obligated to purchase the home at the end of a lease option, though you will be out the extra fees you paid towards it.

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 good for?

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. Steve Nicastro, a former real estate agent and current content team lead 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

“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

Rent-to-own agreements are a good solution for some buyers who need a house-buying alternative due to finances or creditworthiness. These agreements allow tenants to test properties and neighborhoods, offering a hands-on experience before making a long-term commitment. However, these agreements have some downsides, such as the higher costs or the initially limited control of the property.

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

Pros

  • Flexible requirements: RTO contracts are less strict than lender qualifications when it comes to credit score and income requirements.
  • Build up a down payment: You can opt for higher monthly rental payments instead of trying to come up with a large down payment.
  • No bidding wars: Once you are in the contract, the seller cannot entertain other offers.

Cons

  • Nonrefundable: You can change your mind, but you won’t be able to recoup the extra fees for entering the agreement.
  • Complex contracts: RTO contracts can be very confusing and include legally binding terms that you need to be aware of before signing.
  • Limited selection: “The RTO homes market is very small compared to traditional listings and rental properties,” said Nicastro. “I believe it makes up less than 5% of the total market.”

» MORE: How to get preapproved for a mortgage

How to rent-to-own a house: step-by-step

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.

Decide if you want to work with a real estate agent

While an agent isn’t as necessary as a traditional mortgage transaction, they can help contact and find owners willing to enter an RTO agreement.

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. 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.

Negotiate lease terms and purchase option

If the owner agrees to an RTO, 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.

Consult an attorney

It is advisable to consult with a real estate attorney to review the rent-to-own agreement and ensure your interests are protected.

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: If this fee is in your contract, it could cost you another 1% to 2% of the home value.
  • Inspection and appraisal fee: These fees typically range from $250 to $600, depending on your area.

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    FAQ

    What credit score do I need for a rent-to-own agreement?

    The credit score expectations in a rent-to-own agreement can vary depending on the landlord-seller and the specific terms negotiated. Some landlord-sellers may be more lenient and willing to work with individuals with lower credit scores, while others may prefer tenants with higher credit scores to mitigate their risk.

    Does rent-to-own hurt your credit?

    Typically the lessor in a rent-to-own agreement doesn’t report your payments to the credit bureau, and therefore paying rent will not benefit or hurt your credit score.

    Should an attorney review my rent-to-own agreement?

    Yes. 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.

    Can I qualify for a mortgage while in a rent-to-own agreement?

    Yes, and there is a good chance you will need to qualify for a mortgage loan to purchase your home after the lease agreement is up. The rent-to-own agreement gives the lessee, or tenant, the opportunity to improve their credit score to qualify for a loan.

    Bottom line

    Rent-to-own homes offer a unique way to homeownership. This is an especially desirable option for those facing credit constraints or limited savings. 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.


    Article sources

    ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:

    1. Nolo, " The Basics of Rent-to-Own Agreements .” Accessed June 5, 2023.

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