Is Rent-To-Own An Affordable Way to Buy a Family Home?

Well, not exactly. There are two sides to rent-to-own agreements: The first is what is advertised to attract homebuyers; the second is the truth about costs and contracts. Here’s the skinny on both.

If you are considering a rent-to-own (RTO) home option instead of taking out a traditional mortgage immediately, you may think you're getting the best of both worlds. RTO arrangements are particularly beneficial for people who cannot afford the down payment of a mortgage, have less-than-stellar credit histories, or who have unpredictable income.

This alternative route to homeownership sounds ideal, but only 20% of rent-to-own agreements result in a fulfilled sale. And it has many hidden costs that make it less affordable than it initially seems.

How does 'rent-to-own' work?

RTO allows a person to rent a property without having to commit to buying it outright. RTO has become a popular route to ownership for first-time homebuyers and those who can't afford to buy in today's expensive real estate market. The terms are as straightforward as the name sounds. You rent the property first, paying a contractually agreed upon rental amount that may (or may not) be partially applied to a future downpayment on the home.

An image of a woman carrying brown boxes out of her house.
Getty Images.

Things get more nebulous and varied when you talk about ownership. Because these are individual negotiations between a landlord and tenant, they vary greatly and are not contractually standardized. Under some terms, rent may be credited towards the purchase price of the home. Under others, when the lease is up, the tenant still has a downpayment to pay. Worst case scenario, the sale doesn't happen, the lease ends, and the rent-to-own agreement is voided. It sounds simple enough, but complications and questions along the way could truly shortchange RTO buyers.

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Things to Keep in Mind

Option Fee vs. Down Payment

On paper, rent to own seems like a dream come true. You can finally get your own home without the bank constantly chasing after you. However, most RTO buyers are not really getting a good deal.

With a traditional purchase, a buyer takes out a mortgage and pays a down payment that typically ranges from 5% to 25% of the total purchase price of the home. The median down payment averages 12% in the U.S. So, on a $200k property, the bank will expect the buyer to pay somewhere between $10,000 and $25,000 as a down payment. This can be offset by seller's credits and other discounts, but the buyer is also expected to pay for appraisal, title, and inspections, which can run well above $1,000.

An RTO agreement could minimize the need for such a large deposit, but most of these agreements have an Option Fee, which is a non-refundable payment that reserves the right to buy the property by a mutually agreed upon date. This fee usually is about 5% of the price of the home, but the seller has the discretion to lower it. On the same $200,000 house, though, a 5% fee is the equivalent of the lowest traditional down payment. Even more concerning is that the option fee is not secured, so there are two major risks:

1. You are handing over money to an individual instead of a registered lender.

If the landlord is a scammer or just simply irresponsible with their money, it could create costly disputes. Even with a signed contract, it can be expensive to fight a legal battle to resolve any issues that may arise.

2. When the rent-to-own term comes to an end, a tenant may be obliged to purchase the home, depending on the contract.

However, if the tenant decides they don't want to be an owner, then that option fee is forfeited.

Verify the title.

Failing to verify the title of the home is a common mistake that many RTO buyers make. With a traditional home purchase, buyers are protected by laws that ensure that the seller of the property is the legal owner of the home. They cannot list the property to the Metropolitan Regional Information Systems (MRIS) or Multiple Listing Service (MLS) if they cannot prove ownership and their right to sell. These assurances protect the buyer.

However, with an RTO agreement, those protections can easily be lost. A landlord doesn't need to show they're the legal owner of the property to execute a lease. Think about it: Property managers do this on behalf of their clients all the time. So, RTO disputes can happen when there are multiple owners of the property. Say, all parties agree to rent the home, so one person lawfully executes the lease. But, that one person doesn't have the right to sell the home without the permission of the other owners. Disputes and disagreements between owners could foil the best made RTO plans.

Because most RTO deals are one-on-one, buyers often don't involve real estate agents, lawyers, or title companies, whose job it is to have their back. These lapses can result in lost money and time, as well as sizable amounts of disappointment.

Mortgage now or mortgage later.

An RTO agreement doesn't mean avoiding a mortgage; it just means delaying it. A lease term could be used to improve credit scores and save for a down payment. However, there's no guarantee that a tenant will be able to secure a mortgage later.

A slight shift of 15 to 20 points in your credit score could spell mortgage approval or denial. Also, the APR might become too high to afford consistent monthly payments. If the buyer doesn't get approved or doesn't agree to the loan terms, the landlord is neither obliged to return the option fee nor to extend the lease.

4 Ways to Make Rent-to-Own Benefit the Buyer

If you're still willing to take the risk on the rent-to-own option, then be sure to consider these four factors before signing a contract.

Be realistic about your finances.

Work with a bank early on to understand what you would need to do to qualify for a mortgage when the lease term is up. Sometimes it is as simple as credit repair, but other times you'll need to get a new job with higher W2 income, pay back taxes, and show proof of funds in the bank. Use the lease term wisely.

Make sure the title is clear.

When you're entering the contract, do a title search and get title insurance. This way, you'll be sure that, legally, the home is in the name of the person you're buying it from. It would be devastating to have someone come knocking years later claiming to own your new home.

Ensure all seller costs are paid before you take ownership.

Before you get complete ownership of the home, make sure the mortgage, taxes, and other outstanding charges on the seller's side are paid. This can include back taxes, utilities, and even homeowner's association dues. To ensure you won't be responsible to pay the seller's leftover bills, get proof of payment in writing from these service providers.

Hire a professional.

Rent-to-own agreements are not as straightforward as they seem. These contracts are typically made to favor the seller, and sellers expect that buyers might be too vulnerable or naïve to catch clauses to their disadvantage. Be sure to hire a real estate agent and a lawyer, who can help review the agreement and negotiate terms that are realistic and fair.

The Bottom Line: Know Your Rights

It makes sense that many aspiring homeowners find rent-to-own attractive. If you're seeking long-term stability—you love the schools, the neighbors are great, and other homes in your area are just beyond your means today—it is reasonable to try to secure the home you're already in.

However, these agreements with a landlord should never be handled with a gentleman's handshake. Take the time needed to do business, just as you would if you were purchasing the home on the traditional market. Hire an agent and a lawyer who can advocate for your rights and explain what you're entitled to know about the owners and the home condition.

And remember that, in many states and cities, existing tenants have the right to first refusal whenever a landlord chooses to sell a residence that is already occupied. So, in situations like that, there's no need to pay an option fee in advance to secure a home that you'd have the right to purchase anyway.

If all of this sounds too messy, then stick to renting and saving until traditional financing is a viable option. At that point, approach the landlord with an offer to buy—or keep your options open for other properties in the area that offer greater value and peace of mind.

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