The information provided on this website does not, and is not intended to, act as legal, financial or credit advice. See Lexington Law’s editorial disclosure for more information.
If you’ve ever heard of the concept of rent-to-own (RTO), it probably sounds very appealing to you. After all, the biggest criticism of renting is that it feels like money down the drain. Rent-to-own seems to fix that, with your rent payments eventually counting toward your property purchase. But if rent-to-own is really as good as it looks, why aren’t more people doing it?
Keep reading for a complete breakdown of rent vs. rent-to-own to understand which option is right for you.
Rent-to-own explained
As a concept, rent-to-own is exactly what it sounds like. You sign a contract on a property stating that while you’re renting it now, you can purchase the home at the end of a specific time period.
If you buy the property, a portion of your rental payments will count toward the purchase. Rent-to-own contracts can range from a couple of months to a few years. Most contracts don’t extend past a couple of years.
There are a few critical components of the rent-to-own process that everyone should know about:
- Option fee: To get into a rent-to-own contract, you typically have to pay a one-time, nonrefundable option fee. This fee is essentially a payment for getting the rent-to-own option. Typically, this fee is between 1 and 5 percent of the property’s final purchase price.
- Base rent: Base rent is the monthly rental payment you and the landlord agree on. Your contract will state what portion of your rent payments will apply to your purchase. For example, if your rent is $1,500 a month, your contract might say that $500 will count toward your principal payment at the end of the contract.
- Rent premium: A rent-to-own contract typically means you pay higher-than-average rent (a rent premium) for the property. Many agreements will apply the rent premium to your principal payment when it’s time for the house purchase. However, if you don’t purchase the home, you typically don’t get the collected rent premium back.
There are two main types of rent-to-own contracts: a lease-option and a lease-purchase agreement. In both cases, you sign a rent-to-own contract stating that the house purchase will be for a certain amount. In a lease-option contract, you get the option of buying the home when your contract ends.
If the agreed-upon price isn’t reflective of the current market value, you don’t like the house or you want to relocate, you can walk away. You won’t get your option fee or rent premium charges back, but you’re not expected to make the purchase.
On the other hand, a lease-purchase contract states that you’ll buy the house at the end of the contract. If the housing market went up during that time, you’re getting the house for a great price, and all is well.
However, if the housing market has fallen or you’re in a worse-off financial situation, you’re now possibly stuck buying a home.
Most people opt for the lease-option contract as it offers more flexibility.
How is rent-to-own different from renting?
The main difference between rent-to-own and renting is that you get to build equity in your home with rent-to-own. This means your rent payments—in addition to paying for your shelter—also contribute to your financial future.
Neither renting nor rent-to-own payments typically affect your credit. (Rent reporting is an option for some renters, but not all.) However, most people who choose a rent-to-own option do so because they have poor credit and can’t get a typical mortgage.
Rent-to-own buys them some time to improve their credit score so that at the end of the contract, they can qualify for a mortgage and purchase the home.
While rent-to-own is excellent in many ways, it’s not without its risks.
The potential downsides of rent-to-own agreements
If you’re considering the rent vs. rent-to-own debate, it’s essential to know the risks associated with RTO. Ultimately, you might not buy the house at the end of the contract. This could be for various reasons.
Maybe you aren’t approved for a mortgage, you don’t like the place after living in it for a while or you have a job offer in a new city. If this is the case, you’ll walk away in a worse position financially.
A rent-to-own contract charges fees and a higher rent price under the assumption that you’ll purchase the home. That option fee and rent premium were all for nothing if you don’t buy the house in the end.
Additionally, if you sign a lease-purchase agreement, you could be forced to buy a home you don’t want. Considering a home is probably the biggest purchase of your life, it’s not a situation where you want to be locked into doing something.
For more information on rent-to-own, examples of contracts, red flags to look out for and ways to shop for the best deal, download the Complete Rent-to-Own Guide for Prospective Homebuyers.
Lastly, there are rent-to-own scams you should watch out for. Popular scams include situations in which the landlord doesn’t own the home, the home has significant damage to it or the property is in foreclosure.
Founder of real estate investment firm Property Cashin, Marina Vaamonde, states, “It is very critical that every prospective buyer understands that the transfer of the property deed doesn’t occur until the closing takes place.” So, if the owner doesn’t keep up on their payments and foreclosure occurs, the rent-to-own contract is void.
Should you rent-to-own or rent?
Which option you should choose depends on your circumstances. The type of people who should consider rent-to-own instead of renting are:
- Those who want to test out homeownership
- Those with poor credit or without significant savings
- Those who want their monthly payments to go toward building home equity
- Those with low incomes
If you’re considering signing a rent-to-own contract, always involve a professional real estate agent. Essentially, this is a home purchase agreement, so a Realtor can help review the contract and make sure you’re fairly represented.
You should not do rent-to-own if you want the flexibility of regular renting or you’re not interested in homeownership yet.
Make a financial plan for the future
As mentioned, many people who choose rent-to-own feel that they’re on the cusp of homeownership but they just need to save more or improve their credit. If you’re considering rent-to-own, the first step is to understand your situation.
Check your credit so you know what your options might be going forward. Can you get approved for a mortgage now? Do you think you can improve your credit in a few months or a year? If you’re too wary of rent-to-own, work on improving your credit and building your savings until you can afford a mortgage you’re comfortable with.
The credit repair specialists at Lexington Law can work with you to review your credit report to make sure it’s accurate.
Reviewed by Vince R. Mayr, Supervising Attorney of Bankruptcies at Lexington Law Firm. Written by Lexington Law.
Vince has considerable expertise in the field of bankruptcy law. He has represented clients in more than 3,000 bankruptcy matters under chapters 7, 11, 12, and 13 of the U.S. Bankruptcy Code. Vince earned his Bachelor of Science Degree in Government from the University of Maryland. His Masters of Public Administration degree was earned from Golden Gate University School of Public Administration. His Juris Doctor was earned at Golden Gate University School of Law, San Francisco, California. Vince is licensed to practice law in Arizona, Nevada, and Colorado. He is located in the Phoenix office.
Note: Articles have only been reviewed by the indicated attorney, not written by them. The information provided on this website does not, and is not intended to, act as legal, financial or credit advice; instead, it is for general informational purposes only. Use of, and access to, this website or any of the links or resources contained within the site do not create an attorney-client or fiduciary relationship between the reader, user, or browser and website owner, authors, reviewers, contributors, contributing firms, or their respective agents or employers.
Lexington Law is not an RTO company. Any content provided on this website regarding the topic of RTO is nothing more than a resource Lexington Law believes might be helpful to readers of its website. Lexington did not write this content. It was provided by a third party. The information provided on this website does not, and is not intended to, act as legal, financial or credit advice; instead, it is for general informational purposes only. Use of, and access to, this website or any of the links or resources contained within the site do not create an attorney-client or fiduciary relationship between the reader, user, or browser and website owner, authors, reviewers, contributors, contributing firms, or their respective agents or employers.