Rent-to-Own Homes Explained: Are They Legit? | NerdWallet

If buying a home is on your bucket list, but you're not quite ready to do it just yet, a rent-to-own home could be a good option for you. But since they're relatively uncommon and there's a lot of legalities involved, there's plenty that you should know before you get into a rent-to-own home. Today, we're going to talk about how rent-to-own homes work. To learn more, I talked to my colleague, Abby Badak-Doyle. So Abby, how does rent-to-own work? So rent-to-own is a legally binding contract. It's also known as a lease purchase agreement in which you agree to rent a home for a set period of time, usually one to three years. And at the end of the lease period, you are legally obligated to purchase the home. The way that a rent-to-own agreement works is there's built-in little checkpoints for yourself to save for a down payment along the way. And that happens in two different ways. So the first is called an option fee. And this is like an upfront mini down payment of sorts, usually one to 5% of the purchase price that you pay at the start of the agreement. And then just like a regular lease, you're going to pay those monthly rent payments. But then in addition to your monthly rent, you'll pay what are known as rent credits or rent premiums, which is a little bit extra on top of your rent every month. And all of that gets socked away into an escrow account that will go toward your down payment when it's time for you to purchase the home. So what are the advantages of doing a rent-to-own compared to just a regular rental? So the biggest advantage is that it's an opportunity to build your credit, right? If you're looking at rent-to-own agreements, it's probably because you're just not quite there financially to buy a home right now. During that leasing period, you can build your credit so that you'll be ready to apply for that mortgage at the end of the rental period when it comes time to buy the home. The second thing is that it gives you some built-in accountability to save for that down payment. So if you're the kind of person that is tempted to tap your savings account like a piggy bank, the built-in rent credits and the option fee are kind of untappable in that escrow fund, so if you need that discipline to put a little extra away, the rent-to-own agreement kind of bakes that right in for you. And finally, it's really tough to move from rental to rental, and it's expensive to move. So if you've found a house that you know that you really like, especially if you have kids and you're looking at a certain school district, for example, rent-to-own gives you that stability during the leasing period of like, hey, I found this house. I really like it. I know it's the one. I'm not quite ready to buy it right now, but after that leasing period, I will be. Rent-to-own locks you in and makes things a little bit more stable than moving from rental to rental. And how do you go about finding a rent-to-own property? Are they available everywhere? This is what's interesting, is that traditionally, rent-to-own agreements were handled like one-on-one, one-off contracts between a property owner and the folks who are renting. So it used to be like, hey, I have this investment property. I'm kind of ready to unload it in a couple of years. I have great tenants. They're looking to buy. Let's work this thing out, right? But now what's changed the game and what's made rent-to-own more accessible to more people are these rent-to-own tech startup companies. So those are more prevalent in larger cities and the suburbs outside of larger cities, just where there's more inventory, although it is possible to find rent-to-own properties in rural areas as well. So since the rent-to-own startups are relatively new and also, you know, they're startups. So by the nature of them, they're kind of also figuring things out and kind of getting their legs under them. What are some things that a buyer or a renter, hopefully turning buyer, should know if they're looking at one of these rent-to-own startup companies? That's a great question. So definitely do a search for recent news, look at customer reviews, check out the Better Business Bureau. Since a lot of these companies are so new, it pays to do your due diligence and do your research to make sure that this is a company, a company that you feel comfortable doing business with. Another important number to find out is what percentage of folks who rent-to-own through this company successfully buy the home at the end? Because if this is all about achieving homeownership, right, that's a really important metric of success. And in terms of like what type of property it is, is rent-to-own usually like single family, standalone houses, or could you also find like condos or townhomes or other types of properties? Rent-to-own are typically single family houses that would include condos and townhouses. Not likely to find a rent-to-own that's like a multi-unit, for example. Some of the rent-to-own tech companies have their own criteria for what types of homes qualify. Some don't allow septic systems or above ground pools, for example, or a certain amount of square footage, or they limit the amount of acreage that can be attached to the home. So especially if you're going through one of those rent-to-own tech companies, look up to see if the types of homes that are available to rent-to-own are the homes that you envision yourself living your life in. Right, that totally makes sense. So once you are ready to buy though, you do still need to go through the traditional mortgage process of applying with a lender and all of that, correct? Yeah, that's right. So after that leasing period is up, you still have to go through all of the qualifications that you would have to go through to get a traditional purchase mortgage. What happens if something goes wrong during the rental period? Either maybe you can't make some of the payments or you change your mind about the house. So rent-to-own is inherently a little bit risky for those reasons. So the first is that there is less flexibility in a rent-to-own agreement compared to a traditional mortgage, because if you fall behind on your payments or if you change your mind and you decide you don't want to buy the house, it's a legally binding contract. So depending on the terms of your contract, which you should read and understand, you could be on the hook for financial penalties or even legal action as well if you don't follow through on your end of the agreement. The other thing that's a little bit risky about rent-to-own homes is that property values can change in that rental period. So let's say that you agreed to a three-year term to lease before you're ready to buy the home and in that three years, property values in the area just plummet. Well, you already agreed to buying the home at a set purchase price when you signed the rent-to-own agreement three years ago, and you would be hard-pressed to find a mortgage lender willing to lend you more money than what your house is actually worth. So you are taking a bit of a risk by extending that leasing term before it comes time to buy the property. Wow. So really, it probably makes good sense to research the real estate market in the area that you're buying so you kind of know what you're going into, know what property values have been like. But that said, no one has a crystal ball. You don't know what's going to happen. Sometimes rent-to-own has a little bit of a reputation for being less savory, let's say. Why is that? So although many rent-to-own listings are perfectly legitimate, it's also a common tactic for scammers who use rent-to-own listings to try to prey on folks who are really eager to own a home and might not do all of the fact-checking necessary before following up on that listing. So some red flags to watch out for are, first of all, basic stuff. Don't wire money over the internet to people that you haven't met, and be really cautious about giving away your personal information. Something else that's a red flag to look for is if a listed much lower than the average market rate rent in your area. So inherently, with those rent credits or those rent premiums being a little bit extra per month on top of your regular rent, anything that's a screamin' deal and lower than average rent in your area should be a red flag. Something else, a common scam to watch out for is a scammer will list a property using photos of a house that they know is vacant, and sometimes they'll go so far as to meet you at the property, show you the house, and then you can sign the contract in person, and then, poof, they take away with your money. So just be really cautious. Trust your gut. If anything seems off, or if you feel like you're being pressured into signing something right away, take a step back. This is a really big decision, and there's no need to rush. And if you feel like you're being rushed, that's probably a red flag. Let's say you've decided that rent own is right for you, and it's something you want to look into. What are the steps you should take to get ready? So you want to make sure you know those basics, right? How much you're going to be paying in rent, those rent credits or rent premiums, how much your option fee is going to be, and then how long you will be leasing before you have the opportunity to buy the home. Another good thing to understand is maintenance. So during the rental period, understanding who's on the hook to pay for routine maintenance, as well as anything big or surprising that might come up during the rental period. You also want to understand how flexible the contract is. So if you have any wiggle room to change your mind, if there's any penalties, if you fall behind on payments, or if you miss a payment. Also, just like any other home purchase, you're going to want to protect yourself with a home appraisal, a home inspection, and a title search to make sure that the person who's selling you the house is actually the person who owns the house or the company in the case of the rent to own tech company situation. Finally, you know I'm going to say it just like any other contract, any other home purchase, it always pays to lawyer up and to have somebody review the contract so you understand those terms. It's important to know that rent to own laws vary by state, so a lawyer who's familiar with those can really help protect you and make you feel confident about your purchase. That makes sense. Thank you so much, Abby. We've learned a ton from you today. Good to be here, Kate. Thanks. If you've had some credit challenges or you're having a lot of trouble saving up for a down payment, know that rent to own homes aren't your only option. There are many different types of mortgages, so it's important to explore what kind of loan might be right for you. It's also a good idea to look into first-time home buyer programs, which can help you with resources like counseling and first-time home buyer education, as well as things like down payment assistance, which can take the form of low interest loans or even grants, so free money to help you buy a home. Either way, these can get you on the path to home ownership. I'm Kate Wood, and I write about mortgages and home buying for NerdWallet. To learn more about home loan options for first-time home buyers, head to our site. But while you're here, like and subscribe for more.