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What is rent-to-own, and can it help me buy a home?
For anyone who feels like they're wasting money on rent, a rent-to-own (RTO) agreement can seem like a good alternative. RTO deals are often attractive for people who want to buy homes but aren't mortgage-ready yet because of bad credit, limited savings, or other reasons.
But is an RTO agreement a good idea? Not usually. As the renter, there's a slim chance you'll end up buying the property and a high likelihood that you'll "throw away" even more money than you would on a traditional lease. According to The National Consumer Law Center (NCLC), "The majority of these transactions are built to fail … There is no evidence that [they] present a viable pathway to homeownership."
Still, some people take the rent-to-own path to homeownership and have a good experience. Understanding how RTO works and the risks involved is essential to know whether it’s a good fit.
Read more: Should you buy a house? How to know if you’re ready.
In this article:
What does rent-to-own mean?
A rent-to-own agreement is a legal contract that lets you rent a home with an option or commitment to buy it at the end of a set time period.
With RTOs, you pay rent as usual, but your monthly payment is typically marked up by a "rent premium" or "rent credit," which is money you can later apply to your purchase. You also have to make an initial payment of around 2% of the home's value that can later be applied to your down payment.
A major downside is that on top of the higher rent payments, you usually have to cover costs that traditional renters don't pay for, including maintenance, property taxes, insurance, and, if applicable, HOA dues. And, most importantly, if you don't end up buying the home — you forfeit all that money.
Read more: Should you buy a home with a homeowners’ association?
Different types of rent-to-own contracts
Rent-to-own contracts are highly complex since they combine both lease and purchase agreements. There's a lot of variation from one contract to the next, but your purchase option will fall into one of these two categories:
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Lease option: The landlord gives you the option to buy the property, but you are not obligated to do so. Usually, you don't have to cover maintenance, insurance, or property taxes, but you pay a non-refundable fee of around $3,000 to $5,000.
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Lease purchase: You are legally obligated to buy the property at the end of the lease, and you usually have to pay for maintenance, property taxes, and insurance while you're renting.
Learn more: What are property taxes, and how much do they cost?
How does rent-to-own work?
When shopping for a rent-to-own property, keep in mind that you're looking for a home you'll eventually own. That means you need to do a lot more footwork than you would to find a regular rental home.
The process of finding a good RTO deal can vary depending on the homeowner and whether or not you go through an RTO company, but here are the best steps to take:
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Speak to several mortgage lenders to find out whether you need to make any financial improvements, such as improving your credit score or paying down debt, to qualify for a home loan. Make sure you can remedy any issues during your RTO agreement term.
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If you're going through an RTO company like Divvy or Verbhouse, set up an account and check to see if you prequalify.
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Find a reputable real estate agent and search for properties that fit your budget. If you're working with an RTO company, it might connect you with one of its partner agents or be willing to work with your Realtor.
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When you find a property, vet it like you would a home you would buy. Research the area and make sure an appraisal and inspection are completed.
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Negotiate with the seller to establish the purchase price. Depending on the terms, the price may either lock in at the beginning of your contract or increase during your lease term. You can also negotiate for a hefty percentage of your rent to apply to the purchase.
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Have a real estate attorney review the contract to ensure the seller owns the property, it's free and clear of mortgage debt or liens, and you understand how to adhere to it.
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If you understand and agree to the terms of the contract, sign the document.
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Make payments for the agreed-upon term, often three to five years. Use this time to work on your credit or other issues preventing you from qualifying for a mortgage.
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As you near the end of your lease, decide if you want to buy the property or forfeit your money. If you want to buy, your rent premium and initial deposit might be applied to the purchase price, and you'll need to secure a mortgage to cover the rest.
Read more: How to get a mortgage
Does rent-to-own save you money?
Rent-to-own agreements are more expensive than they might seem. These deals increase your rent and other living expenses and come with a long list of fees. Here are some costs you might incur and the estimated price for each one:
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Non-refundable option fee: 1% to 7% of the purchase price; this goes toward your down payment if you end up buying the house
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Application fee: Around $75
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Security deposit: 1 to 2 months rent
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Price lock: 5% to 10% of the current purchase price
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Rent premium or rent credit: This varies but will probably be at least a 10% mark-up on rent
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Liability coverage: Around $13 per month
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Other ongoing costs: Maintenance, insurance, property taxes, and HOA dues vary by property
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Surrender fee: 2% of the purchase price; this is what you’ll pay if you decide not to buy the house
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Relisting fee: 2% of the purchase price
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Late payment fee: 5% of rent (not including the rent credit)
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Pet fee: Roughly $300 per pet
Dig deeper: Should you rent or buy a house?
Pros and cons of renting to own
Pros
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Purchase price does not increase when the property value increases
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Rent credit and option fee can be applied to your down payment
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Get familiar with the property before buying
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Opportunity to move in before applying for a mortgage
Cons
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Low likelihood of leading to homeownership
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Option fees and rent credits are typically non-refundable, so you’ll lose money if you decide not to buy
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Payments are higher than the market rent, so monthly payments may not be affordable
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You might have to pay for maintenance, property taxes, insurance, and HOA dues
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Property inspection isn't always allowed; if it is, you might not have the right to see the property inspection results
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A missed payment can terminate the agreement
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Payments don't help you gain equity unless you end up buying the property
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Purchase price does not drop if the property loses value
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If the property value increases, the landlord can refuse to sell
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Legal contract is more complicated than a purchase agreement, and it can be difficult to understand and adhere to
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Lack of consumer protections
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Risk of scams
Is rent-to-own a good idea?
Rent-to-own agreements are usually a bad idea. As the tenant, there's about a decent chance you'll walk away from the contract and lose your money.
How much will you lose? Let’s say you rent a home worth $250,000 for three years with a $2,000 monthly rent payment. You pay an additional $200 per month (10% of the rent) as a rent credit and a one-time $5,000 option fee (2% of home value).
In this scenario, you would lose $12,200 from what you spent on the option fee and rent credits. This doesn’t even include what you paid for maintenance, property taxes, the application fee, and more.
In addition to being costly, RTOs are historically riddled with a handful of other problems:
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The RTO industry has a documented history of using deceptive tactics and targeting communities of color and people with low incomes.
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The Federal Trade Commission (FTC) says these agreements are risky, and there's a chance the landlord doesn't own the property or is facing foreclosure.
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Contract terms are highly complex, and many renters' problems stem from not understanding them.
If you cannot qualify for a mortgage now, you may not want to take the gamble that you'll be able to buy a specific home in a few years. Instead, consider saving money on your own in a high-yield savings account or certificate of deposit (CD).
You can also look for a government-backed loan or first-time homebuyer program that helps you prepare for and afford homeownership. For example, FHA loans are available with a down payment as low as 3.5%, which is less than the option fee on some RTO agreements.
Dig deeper: What are the requirements for an FHA loan?
Rent-to-own FAQs
What happens if you miss a rent-to-own payment?
If your payment is just one day late during your rent-to-own lease, you can void your rent credit for the month and face a late fee. If you miss a full month's payment, your purchase agreement might be canceled, and you could end up forfeiting all fees paid toward your purchase, giving up the right to buy the house, or facing eviction.
How do I find a rent-to-own property?
You can find a rent-to-own property by working with a reputable Realtor who has experience with rent-to-own agreements. Companies post available properties online; however, not all sites are trustworthy, and some charge extra fees. You should research each company before making moves.
Can I cancel a rent-to-own contract?
You can cancel your rent-to-own contract, but you will likely have to forfeit any money you have already put toward your rent credits and option fee, and you may be charged additional fees.
This article was edited by Laura Grace Tarpley.
