Updated August 31, 2021
Owning a home is many a renter’s dream. It’s a goal that can take years of scrimping and saving to squirrel away a down payment — not to mention the careful spending and meticulous bill-paying required to keep your credit score high.
In the meantime, you’re still paying rent, maybe even more each month than you’d pay for a mortgage payment. But what if a portion of your rent were going toward purchasing your rental home at a later date?
That’s exactly the dream that rent-to-own deals are selling, but what’s the catch with rent-to-own homes?
Rent-to-own basics: Crediting rent toward a future purchase
Also known as a lease-purchase agreement, a rent-to-own contract is an agreement between the tenant and the homeowner stipulating that a portion of the monthly rent is credited toward the future purchase of the property.
Then, when the lease ends — typically within 1 to 5 years — you’ve saved up a credit with the homeowner that effectively serves as your down payment.
Sounds ideal, right?
A rent-to-own deal means you can start paying toward a home purchase even if you can’t technically qualify for a mortgage yet.
“Most people considering a rent-to-own purchase either don’t have a high enough income or good enough credit to buy a house right now,” says experienced Washington state agent Hao Dang, who’s sold over 76% more properties in the Seattle area than the average agent.
But renting-to-own isn’t quite so cut-and-dried. There may be additional fees paid to the seller that will not count toward either your rent or your down payment, and you could also be on the hook for maintenance and repairs from the day you move in — but we’ll get into more of all of that shortly.
Is renting-to-own actually a good idea?
These deals carry a risk for both buyer and seller, but renting-to-own can make sense if the deal is structured properly. And because rent-to-own agreements tend to occur organically — they generally aren’t listed and marketed in the same way as conventional sales or rental offers — special terms can often be written in from the outset.
“It’s more of a one-on-one deal based on the personal circumstances of both parties,” says Rick Fuller, a top agent in the San Francisco Bay Area.
Fuller explains that, in his market, rent-to-own agreements usually arise when a landlord is interested in selling their house sometime in the future, and they happen to meet a tenant who is interested in buying but still needs a little time to save up their down payment or raise their credit score. In short: a rent-to-own deal makes the most sense when it’s going to be a win-win for both parties.
Summer Rylander, a HomeLight contributor who sold her own South Carolina home through a rent-to-own agreement a few years ago, agrees.
“My house needed significant updates that I simply didn’t have the cash for, and my tenant was eager to buy in the neighborhood, but she needed time to improve her credit history and didn’t mind an imperfect property,” Rylander explains.
In this case, a rent-to-own agreement made sense because both parties clearly stood to benefit from the arrangement — and they were willing to be patient with one another.
These types of deals can be packaged very differently, however.
A lease-option versus a lease-purchase agreement
Lease-purchase and lease-option may sound similar, but there’s one very big difference: one is a requirement and the other is a choice.
- A lease-purchase, or a rent-to-own agreement, legally binds you to purchasing the home once the lease is up
- A lease-option gives you the opportunity to buy the house before the lease is up
Yes, lease-purchase and lease-option contracts are both types of rent-to-own agreements, and while each can be risky as a buyer, a lease-option at least offers you an out if you later decide the home isn’t actually for you.
Choosing not to exercise your purchase option will almost certainly result in the loss of your option money — that’s the fee you would have either paid as a lump sum up-front, or paid towards each month with your rent payment — but you won’t be on the hook to commit to closing on a home you no longer want.
With a lease-purchase or rent-to-own agreement, you do have an obligation to buy the home.
The real risks of rent-to-own contracts for buyers
Rent-to-own contracts (of the lease-purchase variety) may sound good on paper, but you shouldn’t sign one without carefully considering the drawbacks, too.
Let’s review several possible pain points you should consider before signing a rent-to-own or lease-purchase agreement.
1. You’ll probably pay more in rent every month than you would as a renter
Let’s face it — landlords aren’t going to credit a portion of your monthly rent toward the purchase of the house out of the goodness of their hearts. They’ll expect something in return.
This “catch” is usually more per month in rent than you’d pay in a simple rental arrangement. And not all of that “extra” you’re paying each month is going toward your purchase credit.
For example, let’s say the standard rent for a property is $1,700 a month, but the landlord is offering a rent-to-own deal for $2,000 a month. Don’t expect to be credited for the whole $300 extra you’re paying each month.
In the fine print of this deal, it could turn out that you’ll be credited just $200 of that $300 each month. So, in reality, you’re paying this landlord $100 simply to “save” money for you.
But it may be helpful to shift perspective and think of this as a convenience fee because few homeowners will choose to delay the sale of their home by a year or more when they could otherwise probably close in 30 days once their house is under contract — especially during a hot seller’s market, where you’re unlikely to be the only interested buyer.
2. You’re paying less toward the price of the house than you’d think
Putting several hundred dollars a month toward the purchase of a house before you can actually afford a mortgage sounds like a smart financial move on the surface.
But when you run the numbers, you’ll see that the sum total of the credit doesn’t actually amount to much, even in the long run.
“It’s just like leasing a car. If you actually pay off and purchase a leased car, you’ve paid a lot more than if you’d simply purchased the car outright,” explains Dang.
Let’s say you’re paying $2,000 a month in a rent-to-own deal on a $400,000 home — and the landlord agrees to put $200 a month (or 10% of your rent) toward the price of the house.
That’s only $2,400 in one year.
In five years (the maximum of most lease-purchase agreements), that’s a total of only $12,000 that’ll be credited against the agreed-on purchase price.
And you could pay that much just to get into the deal in the first place, because…
3. Most rent-to-own contracts require a nonrefundable upfront fee
Sure, renters expect to pay fees to lease an apartment or house for things like security deposits and application fees — sometimes as much as two-months’ rent.
But if you’re opting for a rent-to-own deal, expect to feel a little sticker shock.
Most lease-purchase agreements require an upfront, nonrefundable, one-time fee that’s calculated by the home valuation. While the amount is negotiable, it’s typically between 2.5% to 7% of the agreed-upon purchase price.
Do the math, and you’ll see that you’re paying anywhere from $10,000 to $28,000 (on a $400,000 house) just to get into the rent-to-own deal.
That may be around the same or double what you’ll pay again in closing costs when you eventually get a mortgage on the house.
For example, if you get a 30-year, fixed-rate mortgage for $380,000 (after making a $20,000 or 5% down payment on that $400,000 home), you’ll pay around $12,000 in closing costs in Phoenix, AZ, according to Bank of America’s closing costs calculator.
Alternatively, you could save the upfront fees you’ll pay on a rent-to-own deal, put that money in a savings account — or better yet, a mutual fund — and let it earn interest so you can afford to purchase a home sooner than you could in a rent-to-own deal.
4. You may lock in at a bad valuation
Like the price of gas, home values are constantly fluctuating. Sure, it’s true that, historically, home values increase over time because it’s an appreciating asset.
However, in the short term, list prices rise and fall by thousands of dollars within the span of weeks or months.
That can be a problem with the rent-to-own because most lease-purchase contracts state the agreed-upon sales price of the home in the contract. In other words, you’re locking in the price of the home one to five years before you buy it.
“It is possible for a rent-to-own contract to just set a purchase price range, but typically, you’re negotiating and locking in the price of the house long before you actually buy it,” explains Dang.
“If the property value has decreased when it comes time to purchase the house, the tenant is still locked in to pay the higher price.”
If the home value does decrease below the agreed-on purchase price, be prepared to lose the money you earned as a credit toward the purchase price. You’re likely to run into appraisal problems, and no bank is going to sign off on a mortgage for more money than the house is actually worth. So, unless you’re able to cover the difference, you won’t be able to purchase the property when your rent-to-own contract is up.
Alternatively, the value of the home could increase during your lease period — great news for you, but not exactly enticing for the seller. For this reason, finding a landlord who will agree to a rent-to-own purchase in the midst of a seller’s market as frenzied as 2020 and 2021 have been may be extremely challenging.
5. You’re on the hook for repairs to the house
Not only are landlords unlikely to make a profit-free rent-to-own deal, they’re also not thrilled about dumping money into fixing up a home they plan on selling soon.
Unlike standard rental contracts, the catch with most rent-to-own agreements is that they include conditions that say the tenant pays for all repairs and maintenance to the property.
This puts the responsibility for repairs and upkeep on you.
“I definitely stipulated that my tenant was responsible for maintenance and repairs as soon as she moved in,” says Rylander. “I wanted her to feel as though the home were hers from day one.”
(While rent-to-own contracts do vary by state and could potentially put the responsibility for repairs on the actual homeowner, don’t count on it.)
At first glance, that seems like a reasonable arrangement. After all, you’re planning to own the home in the near future, so you’re probably happy to pay to have repairs done to your satisfaction.
However, this is a risky move, because there’s no guarantee that the deal will go through as planned.
What’s actually happening when the hot water tank bursts, the appliances break down, or the furnace fails, is that you’re paying to replace those items in a home you don’t legally own yet.
“It’s not an ideal scenario,” admits Rylander. “Though my tenant and I both readily agreed to these terms, the advice I would give a rent-to-own buyer today is to be wary if you’re looking at a house that needs work. Repairs or improvements are a lot to take on for a property that isn’t technically yours, and you don’t want to feel resentful before you’ve even made it to the closing table.”
Furthermore, if you default on the lease, you may not be able to buy the house — so you’ll lose the rental credit money and every penny spent making repairs and home improvements.
And it’s surprisingly easy to default on a rent-to-own agreement.
6. Late or missed payments for any reason could kill the deal
When you’re late with your rent in a standard rental agreement, the worst you’re looking at is a steep late fee (unless you’re a repeat offender and eviction is on the table).
No biggie, right?
If it’s a one-time situation due to unavoidable circumstances and you’re otherwise a stellar example of a pay-on-time tenant, then one late payment won’t do much damage. Your landlord may even be so understanding as to waive the late fees.
Honestly, a rent-to-own landlord may be that understanding, too. However, even if they are understanding and waive the late fees, read the fine print on your agreement very carefully, because a late payment may still void the rent-to-own contract.
And it’s not just late payments that are an issue. There’s a long list of scenarios that can trigger a default in a rent-to-own contract, such as violating a “no pets” clause, or failure to make required repairs in a timely manner.
Even if you’re a perfect tenant who’s followed the contract to the letter, there’s still a chance the rent-to-own agreement could be voided.
Let’s say you can’t afford to buy the house, or you fail to secure a mortgage, when the lease is up — don’t expect a refund. Failure to make good on the purchase nullifies the lease and that rental percentage credit you earned vanishes.
7. The rent-to-own setup is vulnerable to scams and shady landlords
As the tenant, you take on most of the risk in a rent-to-own contract.
You’re the one who is (probably) paying more than necessary in rent each month, with the promise that the owner will credit the amount toward the purchase price someday. And you’re the one trusting that the money you spend on repairs is going into a home you’ll own someday.
Your landlord has very little risk because they remain the owner of the home throughout the lease. If you default, they get to keep the house and all the money you’ve paid.
That being said, selling a home through a rent-to-own arrangement is likely not your landlord’s secret retirement plan.
“Honestly, I was stressed every month waiting on the rent check,” says Rylander. “I still had a mortgage payment to make, whether my tenant paid on time or not. People like to make a villain out of landlords, but sometimes we’re genuinely just one person with one property, trying to make ends meet just like you — not every rental scenario is profit-driven.”
Nevertheless, the financial jeopardy you put yourself in is serious enough that the Federal Trade Commission issued a report that rent-to-own agreements can be shady deals and downright scams.
According to the consumer information report, defrauded rent-to-own tenants have found out too late that:
- The landlord can’t legally sell the house because they don’t actually own it
- The seller leaves you with several years of unpaid property taxes
- The house is in disrepair, or has hidden issues like lead or asbestos
- Promised fixes aren’t made after a contract is signed
- The house is headed for or in foreclosure
Should you fall victim to one of these scams and an unscrupulous landlord, then at best you’ll have an unpaid tax bill. At worst, you’ll have spent years thinking you’re paying down the price of a home that you’ll never be able to purchase.
In Michigan, top Battle Creek-based agent Cassie Scramlin warns that there is no real way to know for sure that your landlord is making payments on the home. And even if the foreclosure process begins, you’re still on the hook for your own rental payments as agreed.
“It’s important to understand that [in Michigan] you’re bound legally by that lease-purchase or rent-to-own agreement to make your payments, regardless of whether or not the seller is making theirs,” says Scramlin.
She advises would-be buyers to work with an experienced agent and exercise due diligence to make sure they have the best possible chance of successfully purchasing the home. Scramlin encourages buyers to ask sellers for a title policy search to understand right away if there are any liens, tax issues, or other problems that could delay or prevent a sale.
8. And that’s not all…
In addition to the significant risks and inconveniences of rent-to-own agreements, further drawbacks may include:
Difficulty finding a home
As mentioned earlier, it can be tough to find a seller willing to enter a rent-to-own agreement. When the real estate market is in favor of sellers and available homes are limited, there’s simply little motivation for a homeowner to delay the sale of their home in order to let you rent it first.
Choices may be limited
Even if you find a willing seller, there’s a limit to the types of homes that might be offered as rent-to-own. If you’re looking for a luxury property, for example, it’s unlikely to happen. The same goes for uniquely constructed homes — if you have your heart set on one that has sustainability at the forefront of its design, you’re probably not going to find a seller offering a lease-purchase.
What if you don’t like it?
Admittedly, this could happen even if you purchase a home straightaway, but what happens if you move into a house on a rent-to-own agreement and realize you don’t actually want to own the place? You’re probably not going to get back the money that has been set aside toward your future down payment if you pull out of the deal. And — again, this is where it’s key to read the fine print on any sales or leasing contract — the seller may be able to pursue legal action for your failure to uphold your end of the agreement.
What if you can’t get financing?
Even if you spoke with a lender before setting out to find a rent-to-own property, there’s no guarantee you’ll be approved for a mortgage by the time your lease is up and it’s time to buy. You can help minimize complications by carefully discussing steps to improve your credit score with a mortgage lender early in the process and ensuring that you make timely payments, but unforeseen things can certainly happen.
If you have a lease term of one, two, or even three years before you’ll be obligated to buy the home, lots can change in terms of income, market value of the property, and mortgage interest rates. Proceed with caution.
Bottom line? Do your due diligence
Rent-to-own agreements aren’t automatically a bad idea — they can be a good thing for both buyer and seller — you just need to do your homework before signing on the dotted line.
As Fuller mentioned, an honest conversation with the seller is most likely going to be how you’ll discover the possibility of a rent-to-own or option to purchase after leasing, so use this opportunity to gain understanding. A homeowner who is eager to sell their home is unlikely to choose a rent-to-own agreement as their ideal sales strategy, so if they’re open to the idea, it’s fair to ask them why.
Scramlin also encourages buyers to ask if a homeowner is current on their mortgage payments. While, sure, they could lie and say yes when they’re actually three months behind, most states require posting a notice of default in the public record after a certain period, so it’s quite possible to find out if your home-of-interest is barreling toward foreclosure.
And don’t forget Scramlin’s suggestion to run a check on the title of the home, which will uncover any liens due to unpaid taxes, unpaid repair companies, family grievances, property disputes, and so on.
Finally, even if — perhaps especially if — the home is to be sold as-is, or if you’ll be responsible for the cost of maintenance and repairs during your rental period, do not skip the home inspection. This is your best opportunity to find out what you’re dealing with should you choose to take on this house.
Don’t forget, the drawbacks we’ve discussed apply mostly to lease-purchase agreements, but a lease-option contract isn’t far behind. The latter could be a good deal for you if you negotiate well and it’s written with your interests in mind, but it’s not without similar pitfalls.
So, when does a rent-to-own agreement actually make sense?
Renting-to-own might make sense for you if you know your financial situation will be improving soon. Maybe your mortgage lender has indicated that your credit history will be in good shape to reassess a loan in six months, or maybe you’ve just started a new job with a strong salary and you know you’ll be able to save up a down payment quickly.
Renting-to-own can offer breathing room when you’ve found a home you love but can’t get a mortgage for just yet — but you shouldn’t go in without a plan. Agreeing to rent for, say, three years before trying to buy leaves quite a few unknowns, and the more unknowns there are, the riskier the deal.
Finally, if you’re interested in purchasing the house you’re renting, and your landlord offers you a rent-to-own contract that’s actually a lease-option agreement — don’t automatically say “no.”
Remember, a lease-option provides just that: an option to buy. You may have to pay an option fee for this privilege, but it might be worth the cash if you’re happy in your home and would like the chance to make it your own.
In either case, ask a real estate attorney or a top local agent with rent-to-own experience to review the contract first to determine if the lease-purchase or lease-option is a good deal for you. If it’s not, another option is to simply lease a smaller, less expensive property and put the money you’ll save on rent toward building a down payment for your dream home down the road.
Header Image Source: (Holly Stratton/ Unsplash)