Rent-to-own contracts let you rent a house now and buy it later, often within three to five years. They can be attractive if you want to buy a specific home but aren't financially ready yet, as they give you time to improve your credit and save up for a down payment.
But rent-to-own contracts should be approached with caution. The agreements often contain confusing terms and conditions, and some may require you to buy the home even if your circumstances change.
Before signing a rent-to-own contract, consider the various risks and seek the help of a real estate professional to clarify any confusing terms.
Rent-to-own agreements, explained
Rent-to-own contracts fall into two types: lease-option agreements and lease-purchase. Both allow you to rent a property with the option to buy it down the road, but a lease-option is more flexible.
A lease-option provides the option to purchase the property at the end of the lease term, but you're not obligated to buy it. Because it's the most flexible rent-to-own contract, a lease-option works best if there's a reasonable chance you'll move before the rental period expires.
If you end up not buying, the option simply expires and you can either keep renting or move out. But you'll probably still be on the hook for some kind of termination fee.
Under a lease-purchase agreement, you're required to purchase the property at the end of the lease term, usually at a predetermined price. Typically, you pay higher rent, with a percentage being applied toward your future down payment.
A lease-purchase may work if you're in love with a particular home and area, and don't have any plans of moving shortly. But if you don't go through with the purchase, you can lose all your home savings and risk a lawsuit from the landlord or rent-to-own company.
» MORE: How do rent-to-own homes work?
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
In some rent-to-own contracts, you pay a higher monthly rent because a portion gets saved toward your future down payment. Your agreement may set a predetermined purchase price for the home, which should take local market conditions into account.
Find out whether the purchase price is fixed or negotiable in the future. For example, if real estate prices fall, you may 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. It’s due at signing or may be renewed over the course of the lease.
The cost is typically 1% of the purchase price, though it can be as high as 5%. The median home price at the end of 2022 was $471,200, so your option fee could range from $4,712 to $23,560.
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, which can be a flat amount or around 3% of the would-be purchase price — $14K on a median house.
A lease-option agreement usually lets you walk away with minimal financial impact. But depending on the contract terms, you might lose your option fee or be sued 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. For example, 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.
In addition, 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
- Who pays property taxes
In a traditional rent-to-own agreement, the landlord or company is responsible for paying property taxes, since ownership of the property doesn’t transfer to the tenant until they exercise their purchase option (i.e., until you buy the home).
You may be responsible for property taxes if the IRS treats your agreement as owner financing, or "an installment sale." This could mean:
Your monthly rent is unusually high for your area. Part of your rent payments goes toward building up equity in the home or your future down payment.
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How to negotiate a rent-to-own contract
Rent-to-own companies tend to be pretty 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 terms of the agreement: lease length, option period, purchase price, how to buy the property, and what happens if you want to walk away.
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.
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