The pros and cons of real estate rent-to-own plans

How does rent-to-own work?

Purchasing a home requires a good credit score, a low debt-to-income-ratio, savings, sufficient income, and enough cash to cover the down payment for closing costs. If you need the space a home provides over an apartment but don’t have your financial ducks in a row quite yet, it might be worth considering a rent-to-own plan.

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A rent-to-own contract allows an individual to lease a property and have the option to purchase it later. The agreement is made up of two parts: the lease agreement and the purchase option. The lease agreement is standard. You and your landlord agree on a monthly rent fee, a lease term, and any other stipulations. Make sure to review the contract thoroughly so you adhere to terms. Information to review in your lease includes the following:

• Rent price
• Utilities fees
• Maintenance requirements
• Pet policies
• Lease term
• Security deposit

After reviewing the lease, you sign the agreement and begin your lease term. At the end of your lease or before it, you’re given the option to purchase the property. The purchase price for the property may be established when the agreement is signed and is typically higher than the market value. The purchase price can also be determined when the contract expires.

Rent payments may or may not contribute as payments toward the purchasing option. If they do contribute, the price of rent will likely be higher. This gives you equity in the property, alleviating the financial burden of the initial down payment, and may make it easier to get a mortgage. If you don’t know if your rent payment is affordable, learn how much you should spend on rent.

Rent-to-own agreements may also include an option fee. The option fee is a non-refundable upfront fee which grants you the option to purchase the property in the future. Option fees do not have a standard cost; however, they typically range from 1% to 5% of the purchase price.

Rent-to-own agreements can give you the option to buy or require you to purchase the property. If it’s a lease-option contract, you have the right, but aren’t obligated, to purchase the property. If you decided not to buy the property, you move out at the end of the lease term, like any lease agreement.

In a lease-purchase contract, you may be required to purchase the property at the end of the term. Read your rent-to-own contract carefully to ensure you understand the requirements of the agreement.

Benefits of rent-to-own

• You don’t have to commit to buying: For new homeowners, it can be difficult to know if a home is the right fit just by viewing the property. Rent-to-own agreements allow you try out a property before deciding to purchase it. If the agreement allows it, you can avoid the hassle of paying off a mortgage on a property you ended up disliking.
• You can prepare to qualify for a mortgage: Preparing for a mortgage requires you to have your financial health in order. Rent-to-own agreements give you time to get there. The lease may allow you to invest equity in the property, making it easier to qualify. If your credit is in disrepair, this also gives you time to repair your credit.
• Lock in the purchase price: If you negotiate your agreement, you can lock in the purchase price prior to the lease agreement ending. This gives you a definitive number to budget and prepare for the down payment.

Cons of rent-to-own

• You can lose your option fee and invested equity: If you choose to not purchase the property or are otherwise unable to at the end of the lease term, you will forfeit your option fee and the equity you may have invested in the property.
• Rent is expensive: To compensate for your mortgage and down payment, the rent will likely be higher. If you end up not purchasing the property, this is a downside, as you could’ve rented at a cheaper price.
• Additional fees: The option fee is an additional fee only included within a rent-to-own agreement. Rent-to-own agreements make it easier for consumers to purchase. In the long-term, it’s more expensive than purchasing a home outright.
• You may be responsible for maintenance: In some rent-to-own agreements, the tenant is responsible for maintenance. If emergencies happen on the property, like water damage or a grease fire, your housing expenses can quickly pile up.

Depending on your financial situation, a rent-to-own program may be a viable option to explore. Learn how to buy your first home and more budgeting tips to help get ready for your next real estate step.