Learn more about what’s involved in renting a house to own it – and what to watch out for.
If you’re a renter who’s been hoping to buy a home, you may have heard the term “rent to buy.” It refers to a legal agreement where you buy a home you’re renting from your landlord.
On the surface, the idea seems simple: A portion of your rent payment goes toward a down payment that will allow you to buy the home you’re renting a few years down the road. The reality, however, is more complicated and poses a number of risks.
Renters usually pursue rent-to-own arrangements because they have poor credit or don’t have enough money for a down payment. (The down payment is money you pay upfront toward the purchase of a home. The rest of the home’s purchase price is covered by a home loan called a mortgage.)
The FTC says that renters can lose money on rent-to-own agreements that could instead have been saved for a down payment; it recommends you wait until you’ve saved and improved your credit.
With that in mind, we’ll review some of the basics of rent-to-own and the opportunity and pitfalls they represent.
Rent-to-own is when a tenant signs a rental agreement or lease that includes an option — or requirement — to buy the house or condo later, usually within three years. Under the arrangement, the monthly rent payment would typically include an additional payment that will go toward a down payment for purchasing the home. The lease contract states the tenant's rental payment, how much of the rental payments accrue toward a down payment, and the purchase price of the home.
For example, let's say you signed a rent-to-own lease that set your monthly rental payments at $1,450, with $250 of that payment going toward a down payment to purchase the home for $250,000. This would mean you'd accrue $9,000 over three years toward a down payment — or 3.6% of the purchase price.
Using the $9,000 savings, you could buy the home using a 3.5-percent FHA loan, or possibly even a conventional loan. As long as your pre-approval in the beginning of the process determined you could afford this, it might be a good deal.
If you can't afford the extra payment to become a home buyer, but still want to rent the home, you could ask the seller if the home could be rented for less without the rent-to-own option. This may be the case, because some mortgage lenders only allow the down payment accrual to be a sum that's above the local market rent. So in the example above, renting without a rent-to-own option could mean your rent is $1,200 — the $1,450 original rent minus the $250 that would have gone toward the down payment.
The process of buying a home you’re renting can be complex, which makes it ripe for scammers who prey on people’s dreams.
Scams reported by consumers include:
Offering a home that is not owned by the person presenting themself as the owner. In this scenario, the scammer finds a vacant home for rent or sale and advertises it online as a rent-to-own home with their own contact information. They may ask for an application that includes your sensitive personal information that they can use to steal your identity, or they may ask for upfront fees or a non-refundable deposit before disappearing.
Selling a home without disclosing that it’s in foreclosure. When you buy a property, you assume all liens, unpaid taxes and other encumbrances that come with the property. If the owner hasn’t paid taxes in years, those taxes become your responsibility.
Selling a home with undisclosed hazards. Sellers are required to disclose known defects, such as lead paint, asbestos, mold and water damage, among other things.
Other issues include pricing the home way above market value so you’re paying more than the home is worth, and contract requirements that can cause you to lose your down payment or the right to purchase the home if you’re late or miss a single rental payment.
Because there is no industry standard template for writing rent-to-own contracts or rent-to-own leases, you should always have an attorney look at a rent-to-own contract or lease. You need to be clear on who's holding the down payment funds, and on specific state regulations and tax considerations.
It’s also a good idea to consult a real estate agent who can help ensure that the home is priced correctly based on other recent sales in the area, and help you line up experts to evaluate whether the house is sound or needs work.
If you think you might be getting scammed, contact your state consumer protection agency.
1. You won’t have to move twice. The obvious benefit of rent-to-own options is that your housing plans are in place all at once. This works if you don't want or need to move.
3. You can budget for future payments. Knowing how much you’ll be paying for your home in the future could make it easier to plan financially.
1. You could be on the hook for repairs and maintenance. Because you’re paying a premium on top of your rent to buy the home later, make sure you understand what you’re getting for that premium before you sign anything. Some contracts may require you to maintain the property and pay for repairs — obligations that usually fall to the landlord when you’re renting.
2. You’ll have to treat the rental as a purchase, even if you opt not to eventually buy it. You’ll want to have the property inspected just as if you were buying it today to make sure there are no major problems that will cost you down the road. This would usually require an independent appraisal to make sure the home is worth what you’ve agreed to pay. You also want to be sure the owners are current on property taxes so you won’t get stuck with that bill later.
3. Your choice of homes is limited. Most homes for sale are not rent-to-own, so you’ll be shopping from a smaller pool of homes that fit that bill. And if you need to move before buying, you could lose your down payment.
Rent-to-buy homes typically cover two options:
Lease-option This gives you the option to buy the home, and could have conditions under which you lose that option, say if you’re late on a payment or don’t hit deadlines for notifying the seller that you intend to exercise the option to buy.
Lease-purchase This option obligates you to buy it, and you could have legal liability and/or lose the premium you paid toward a down payment if you don’t buy the home when the lease expires.
Individual homeowners offering a rent-to-own option for their leases usually set up contracts for three years. Institutional homeowners (like real estate investment companies) often have two-year lease contracts that can be extended for up to four more years after the initial lease term to provide more flexibility for buyers.
Institutional rent-to-own companies are often publicly traded, so they're subject to a host of regulatory scrutiny that could offer more consumer protection. For instance, their contracts could be more clear about the rules of engagement, how the down payments will be held, and how disputes are resolved.
Down payment assistance programs are typically run by state and local governments and nonprofit community groups. They’re designed for households who can afford monthly mortgage payments but don’t have enough money to put down toward the purchase.
The U.S. Department of Housing and Urban Development has a state-by-state list of programs that provide assistance in buying homes. A real estate agent or mortgage lender may know about additional programs in your state or local area.
Zillow also can help you find creative ways to save up.
