Rent-to-Own Contracts: What You Need to Know

Rent-to-own contracts allow you to rent a house now and buy it later, typically within three to five years. These agreements can be appealing if you want to purchase a specific home but aren't financially ready yet, providing time to improve your credit and save for a down payment.

However, it's essential to approach rent-to-own homes with caution. These agreements often have complex terms and conditions; some may even require you to buy the house regardless of changing circumstances. 

Before signing a rent-to-own contract, carefully consider the risks and seek guidance from a real estate professional to clarify any confusing terms.

Rent-to-own agreements, explained

Rent-to-own contracts come in two types: lease-option agreements and lease-purchase agreements. Both allow you to rent a property with the option to buy it later, but a lease-option offers more flexibility.

Lease-option

A lease-option provides the option to purchase the property at the end of the lease term without any obligation to buy. This type of contract is ideal if there’s a chance you might move before the rental period ends. If you choose not to buy, the option expires, and you can either continue renting or move out.

However, you might still have to pay a termination fee, which typically ranges from 1-3% of the home's price (e.g., $4,000 to $12,000 on a $400,000 property). For example, popular rent-to-own companies like Landis and Divvy charge a substantial fee (3% and 2% of the home price, respectively) to people who do not purchase the house.[1]

Lease-purchase

Under a lease-purchase agreement, you must purchase the property at the end of the lease term, usually at a predetermined price. Typically, you pay higher rent, with a percentage applied toward your future down payment.

This type of contract can be a good fit if you’re committed to a specific home and area and don't plan on moving soon. However, if you fail to complete the purchase, you risk losing all the money you've put into the home and may face a lawsuit from the landlord or rent-to-own company.

Key factors to consider

Length of the lease agreement

The lease period usually lasts one to five years. Make sure you have enough time to prepare your finances and that your lease length aligns with your timeline for purchasing a home.

Monthly rent and predetermined purchase price

You’ll pay higher monthly rent in many rent-to-own contracts because a portion goes toward your future down payment. Your agreement may set a predetermined purchase price for the home, reflecting local market conditions.

Determine whether this purchase price is fixed or negotiable in the future. If real estate prices fall, you could be locked into paying more than the market value for the home.

Fees and up-front costs

Rent-to-own agreements often include an option fee for the right to buy the home at a future date for a specified price. This fee is due at signing or may be renewed throughout the lease.

The cost is typically 1% of the purchase price but can be as high as 5%. The median home price is $420,800 (according to the Federal Reserve Bank of St. Louis), so your option fee could range from $4,208 to $21,040.[2]

Termination fees

If you don't or can't buy the property at the end of the option period, you may need to pay a termination fee, a flat amount or 1-3% of the would-be purchase price. For a median-priced house, this could be more than $12,000.

A lease-option agreement usually allows you to walk away with minimal financial impact. However, depending on the contract terms, you might lose your option fee or face a lawsuit for breach of contract if you don’t buy the property at the end of the lease term.

Rights and responsibilities

Knowing who's responsible for the cost of repairs during your lease period can get murky. Your rental agreement should cover:

• If you can make cosmetic changes, like painting and switching out fixtures
• Penalties for late payments, such as late fees or interest
• If you can have pets, what kind, and how many
• If you can host long-term guests or large parties

Remember that you may be responsible for common fixes, like a leaking kitchen sink or a broken dishwasher, while the property manager covers more expensive issues, like HVAC maintenance.

Property taxes

In a traditional rent-to-own agreement, the landlord or company is responsible for paying property taxes, since ownership doesn’t transfer to the tenant until they exercise their purchase option (i.e., until you buy the home).

However, you may be responsible for property taxes if the IRS treats your agreement as owner financing, or "an installment sale."[3]

How to negotiate a rent-to-own contract

Rent-to-own companies tend to be rigid with their requirements, but you can still tailor the contract. If you find a homeowner or independent landlord willing to enter into a lease-option or lease-purchase agreement, here are some tips to help you negotiate.

Research the market: a comparative market analysis (CMA) of recent home sales in the area will give you an idea of the property's fair value — and if the purchase price and rent are reasonable.

Fine-tune the agreement terms: lease length, option period, purchase price, how to buy the property, and what happens if you want to walk away.

Share a copy of the signed agreement with your realtor or attorney, and get any changes to the agreement — even minor ones — in writing.

Get advice from a pro: An agent can run a free CMA, help you negotiate more favorable rent payments and purchase prices, and arrange other options.

Get advice from a pro: an agent can run a free CMA, help you negotiate more favorable rent payments and purchase prices, and line up other options.

More to consider

How Do Rent-to-Own Homes Work?

Learn more about rent-to-own homes, including how they work, if they're a good idea, and how to find listings in your area.

How to Rent-to-Own a Home With Bad Credit

Learn how to rent-to-own a home with bad credit in our 2023 guide. Discover options for rent-to-own properties, credit score requirements, and alternatives to consider.

5 Signs of a Rent-to-Own Scam (and How to Avoid One)

Rent-to-own is an unregulated market that’s prone to scams. Learn the key signs of rent-to-own scams to avoid losing your hard-earned money.