How Rent-to-Own Properties Operate

You've just secured the home of your dreams, signed the papers, and loaded up the moving van -- you're all ready to go, right? Not quite if you haven't sold your current home first. So you list it, and wait. And wait. And wait. In many cities where renting is more financially viable than owning, buyers may not show much interest. In other areas, buyers do appear, but they might not have enough saved for a down payment, or their credit might not qualify them. How will you ever sell this house?

For many, a rent-to-own home could be the ideal solution. Also known as a lease-to-own property, this arrangement operates similarly to a car lease: Renters pay a fixed monthly amount to live in the home, and after a designated period – usually within three years – they can choose to purchase the property. Each rent payment contributes to the seller’s income, with a portion set aside for the buyer’s down payment toward eventually buying the home.

Both renters and sellers must fully understand the terms of the agreement they create before committing to this arrangement. Rent-to-own offers both pros and cons for each party. Sellers who’ve already bought another home can avoid the burden of two mortgages, and in a sluggish housing market with numerous homes for sale, this may be their most viable option. Buyers who can't yet afford a home might find this to be a faster path to ownership.

Continue reading to understand how the rent-to-own system operates.

Steps Involved in Rent-to-Own Properties

If your house has been listed for months and you're unable to keep up with mortgage payments for both your new and old homes, you might be feeling desperate to sell without losing money. This could be the right moment to consider turning your old home into a rent-to-own property.

Before entering into a rent-to-own agreement, sellers must determine both the sale price and the rent they will charge for the house. These amounts are negotiable, just as with a traditional sale. However, both parties need to remember that once the agreement is signed, the sale price is fixed for the duration of the rental period, which can range from one to three years. Even if market prices change during this time, the agreed-upon price remains unchanged.

Renters are also required to pay an option fee along with a rent premium. The option fee is a fixed sum that the renter pays to the seller. If the renter decides to purchase the house at the end of the lease, the option fee counts toward the down payment. If the renter chooses not to buy the house, the option fee is kept by the seller. Rent premiums are an additional amount slightly higher than the standard rent, with a portion of this extra amount going toward the down payment.

Here’s a typical scenario: The house is valued at $200,000, with standard rent being $1,000 per month. A renter opting for a rent-to-own arrangement might pay $1,200 per month, receiving a $200 rent credit each month. Along with an option fee, in this example $5,000, over a three-year lease, the renter would accumulate $7,200 in rent credits. Adding this to the option fee, the renter has saved up $12,200 for a down payment.

This arrangement is a great option for buyers who might otherwise struggle with a credit score or have not saved enough for a down payment. For sellers, eager to move on from their old home, this setup provides financial relief, even if the house doesn’t sell once the lease period ends. If the renter decides not to purchase the house, the seller retains all the money.

Like any business contract, there are risks and disadvantages for both parties. What happens if someone else offers a higher price for the house than the agreed-upon amount? Who is responsible for fixing a leaky roof in the middle of the night? Keep reading to learn about the pros and cons for both renters and sellers.

Risks and Rewards for Buyers

For many people, purchasing a home will be the largest investment they ever make. Both buyers and sellers must carefully evaluate their options before committing to any binding agreement. Here are some key pros and cons for buyers:

All the maintenance tasks that were previously handled by someone else in a rental property now fall on the buyer, even during the rental phase. From cleaning the gutters to paying for a replacement washing machine when the original washer breaks, the renter must handle these responsibilities themselves.

If you're the seller in a rent-to-own agreement, the next page outlines the details of the deal from your point of view.

Seller's Risks and Rewards

Here are some advantages and disadvantages sellers may encounter when entering a rent-to-own contract:

Given the various concerns on both sides of a rent-to-own agreement, it is highly recommended that both buyers and sellers consult with real estate attorneys (separate attorneys for each party) to ensure they fully understand their rights and obligations [source: University of Tennessee Law School].

In the following page, we will examine various alternatives to the rent-to-own model.

Other Options Besides Rent-to-Own

Considering the advantages and disadvantages for both buyers and sellers in a rent-to-own agreement, it’s important for both parties to explore alternatives to this type of arrangement.

Wraparound financing is an option frequently used when the seller has an outstanding mortgage and the buyer has sufficient income but is unable to secure a mortgage for various reasons. In this scenario, the buyer makes a down payment upon purchase and signs a promissory note for the remaining balance, plus interest. The buyer then makes regular payments to the seller, who uses those funds to pay off the existing mortgage. This arrangement benefits both parties by saving on closing costs and allows the seller to earn interest on the amount that is slightly above the existing mortgage rate. However, risks remain: The seller depends on the buyer’s payments to cover the mortgage, and despite timely payments from the buyer, foreclosure could still occur if the seller defaults on the mortgage [source: Kass].

Under a land installment contract, the seller agrees to transfer the home and the land it sits on to the buyer only after the buyer fulfills specific conditions outlined in the contract, generally including payment of the purchase price plus interest. This method is often used when the buyer can only manage a small down payment and lower monthly installments. In such cases, either there is no mortgage or the existing mortgage is paid by the seller, who must clear it before transferring ownership. The buyer should verify the seller’s ownership of the property before entering into such an agreement. Like rent-to-own, the buyer is usually responsible for property repairs and may also need to cover property taxes and homeowner’s insurance [source: Southeastern Ohio Legal Services].