Is Rent-to-Own a Good Way to Purchase a Home?

While rent-to-own agreements can be more affordable than standard home purchases—all with the added benefit of letting you live in the home before you buy—they aren’t without their risks.

Even if you’ve never bought a home, the odds are good that you know someone who has, which means you’ve also had the pleasure of seeing them slowly but surely lose their minds all throughout the home-buying process. Going from renting to owning in one fell swoop is not for the faint of heart.

Couldn’t there be a better way? One wherein a person eased into home ownership? Maybe even a process where they got to actually live in the house before taking out hundreds of thousands of dollars in debt to purchase it?

As it turns out, there is such a way to buy a home. You can do a rent-to-own agreement! But it too comes with a lot of risks and potential downsides—especially for the person doing the renting-to-owning. It can be a great solution for certain folks, but whether or not rent-to-own is right for you will all come down to the specifics.

Here’s what you need to know…

What is a rent-to-own agreement? 

As you might have guessed, rent-to-own agreements are based on the principle of one person renting a property from another person or company with the option to buy the property at the end of their lease. A portion of the rent payments generally goes towards the cost of the home sale, which can make this a more affordable option than just buying a home outright.

Cornelius Charles is co-owner of Dream Home Property Solutions, LLC, a California-based residential real estate investment company. He said that, “Rent-to-own agreements can work in various ways, depending on the agreement between the seller and buyer. In general, the buyer agrees to lease the home from the seller for a certain amount of months or years, and then they have to option to buy the home at the end of that term.”

“The length of the term, monthly lease amount, selling price, and down payment (as applicable) should all be agreed upon up front and included in the paperwork,” he continued. “If the buyer chooses not to purchase the home at the end of the term, they normally lose out on all monthly payments as well as the down payment.”

“From a buyer’s perspective,” said Daniela Andreevska, Marketing Director at real estate data analytics company Mashvisor (@Mashvisor), “a rent-to-own offers the option to buy a specific home in the future at a price fixed in the present. Under a rent to own agreement, the renter/buyer pays an upfront purchase option fee, which goes towards the down payment, after which he/she moves into the property and starts paying a monthly rent, going towards the purchase price. A rent to own agreement usually lasts for two-five years.”

What are the pros of rent-to-own? 

Doing a rent-to-own agreement can be a great way to buy a home if you don’t have the credit score or the savings to buy a home in the short-term. Saving up for a proper-sized down payment is hard! And extra time to help build your credit score is never a bad thing either.

“An individual with a poor credit score can start buying a home right away,” said Andreevska. “With a rent to own agreement, even people who can’t qualify for a mortgage at the moment can become homeowners in a few years. This means you have time to work on your credit score to get it to a level where you can afford a mortgage.”

Additionally, doing a rent-to-own agreement lets you build equity in the home and possibly save money on the overall price tag all the while giving the home itself a test drive.

“You don’t have to waste money on rent as all the monthly rent you pay goes towards the purchase price,” said Andreevska, adding that, “You can buy a home in the future for a price fixed in the present. Of course, you have to make sure the seller has not inflated the price too much to cover for this time lap.”

Lastly, she pointed out that “You get to live in the property before buying it, so you can make absolutely sure that it’s the right home for you.”

“The main benefit to the buyer is that you get into a home of your choosing while you take the time to fix your credit/finances as needed to be able to qualify for a mortgage to pay off the seller at the end of the term,” said Charles.” Other benefits could include having a stable place to live and locking in a price at today’s prices if the housing market is rising.

What are the cons of rent-to-own? 

Before you get too starry-eyed, you should recall that these deals come with a lot of risks. One thing about rent-to-own agreements is that they can vary widely from deal to deal, which means that the most important thing for you as the renter is to make sure that your loan agreement doesn’t unfairly advantage the other party.

“It’s all in the details,” said Kyle Alfriend, managing partner of the Alfriend Real Estate Group, (@AlfriendGroup). “There is no limit to the variations in rent-to-own leases.  Typically there are four key factions: Initial down payment, rent, final purchase price, and timeframe to purchase the home. How these terms are structured will determine if it is the right lease for you.”

Alfriend listed out some key questions and potential negatives:

  • Initial Down Payment: Is this money applied to the purchase of the home?  What happens to this money if you are unable to purchase the home due to no fault of your own? How is this money held?  Is it held in an interest-bearing account?
  • Rent: What is the rent compared to traditional rents in the area?  How much of the rent is applied toward the purchase of the home?
  • Final Purchase Price: Is the price set in the initial lease? How does the price compare to current market values? Is the price adjusted if the home does not appraise for the agreed upon value, making it impossible for you to get a loan? How are discovered defects in the home handled?
  • Time Frame: Are there incentives, such as a price reduction, if you are able to purchase the home before the deadline?  Can the deadline be extended if you are unable to obtain financing?”

And even with a rent-to-own agreement, buying a home is still very expensive.

“If you decide not to go ahead with the purchase, you will lose the option fee. It is not refundable,” said Andreevska. “Usually the option fee is quite high, so you still have to have at your disposal a considerable amount of money.

A credit score that’s still pretty lousy come to the end of the lease could also spell trouble, as could an unfavorable change in the housing market.

“You might still not qualify for a mortgage loan after the end of the rent to own agreement. Interest rates on mortgages will have probably gone up meanwhile,” said Andreevska. “If you live in a market where real estate prices depreciate instead of appreciate, you will actually end up paying more for the property than what it is worth at the end of the agreement.

Lastly, she points out that you’ll still be a renter during the lease period:

“You are not the owner of the property until you pay in full, which means that the owner/seller makes all major decisions.”

It’s all in the details.

If you’re considering entering a rent-to-own agreement, you need to make sure that the terms are fair and affordable. Anything other than that and you should be prepared to walk away. Get ready to get down there in the weeds.

“Every rent-to-own option is different,” said Alfriend. Here is the standard format that he uses:

  • Initial Down Payment: 5 percent, applied toward the purchase, forfeited if not purchased the home on the agreed-upon terms, by the agreed upon timeframe.
  • Rent: Market rate. You also have the option to pay extra, which will be applied toward the purchase.  I will match any additional rent paid up to $ 300 per month. All these funds are applied to the purchase but forfeited if not purchased on the agreed upon terms, by the agreed upon timeframe.
  • Price: “10 percent above current market.  If the home does not appraise, at my option, I can either refund your down payment or reduce the price to the appraisal.
  • Time Frame: You have three years to purchase the home. If you purchase the home, all funds are applied to your down payment and all is good.  If you choose not to buy and move out, all funds are forfeited. If you are unable to purchase the home but wish to stay in the home and extend your option to buy, I will create a new lease-to-own agreement, and reserve the right to establish a new purchase price and rent amount. If you agree to the terms, all funds you paid on the prior lease will be rolled over and applied to the new rent-to-own agreement.”

It’s probably not a great idea to sign a rent-to-own agreement if your only financial hope for the future involves winning the lottery. But if you have a clear path forward money-wise, you might do well to bet on yourself.

“Rent-to-own agreements are usually most appropriate when the buyer has high confidence that they can qualify for a loan at the end of the term,” said Charles. “Usually, this is for the self-employed or those who do not report a consistent income. They are also appropriate for those with a lower credit score who have confidence that they can get it higher in a few years.”

“For those with lower incomes,” he offered, “this may be appropriate if you have confidence that your pay will increase enough to qualify for a loan high enough to purchase the home at the end of the term. Also, if the down payment is very low or refundable, this could be a low-risk way to potentially get in a home without losing out on much/any more money than you would by renting a home.”

Lastly, Alfriend offered some advice that takes into account both the seller’s perspective as well as your need to anticipate big changes:

“Rent-to-own can be a very good option for people in certain circumstances. However, you are tying up the hands of a seller over a home you may or may not ever buy.  To do this, you must compensate the seller for their risks. If you end up buying the home, on the agreed upon terms, all is good. But what about those unforeseeable situations, such as changes in jobs, marriage, children? You must protect yourself in the lease to cover these changes.”

Buying a home is complicated. And while buying a home through a rent-to-own agreement might be slightly less expensive—or at least slightly more affordable due to the costs being spread out—it’s still fairly complicated as well. (And it’s certainly more complicated than you’ll find with a typical bad credit loan.)

Look on the bright side: No matter what method you use to purchase a home, it’ll be good practice for the complicated demands of homeownership itself! To learn more about borrowing money when you have bad credit, check out these related posts and articles from OppLoans:

What else do you want to know about buying a home? Let us know! You can find us on Facebook and Twitter.

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Kyle Alfriend is a licensed broker through Re/Max, and the managing partner of the Alfriend Real Estate Group, (@AlfriendGroup) located in central Ohio.  He has been actively investing in real estate for 30 years and has been involved in the purchase of over 1,800 properties. His primary focus is the acquisition and remodeling of distressed properties in quality neighborhoods.  He then places those homes for rent or lease-to-purchase.
Daniela Andreevska is the Marketing Director at Mashvisor (@Mashvisor), a real estate data analytics company which helps investors in the US housing market make better and faster investment decisions.
Cornelius Charles is co-owner of Dream Home Property Solutions, LLC—a residential real estate investment company located in Ventura County, California.

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