How Do Rent-to-Own Homes Work? Hint: Not to Your Advantage

In this illustration, it shows a person saving up to buy a house.
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Maybe you’ve seen ads on places like Zillow and Craigslist for rent-to-own homes.

You put a little money down, rent the property for a few years and eventually get the option to buy the house.

Supporters say it’s an accessible alternative to skyrocketing housing costs and high interest rates, giving everyday people with lackluster credit scores or limited savings a shot at the American dream.

But rent-to-own homes have more cons than pros. You could be on the hook for repair and upkeep on a home you don’t even own.

You’ll still need to save up money for a down payment too, and overlooking details in your contract could cost you even more money — and no home to show for it.

Here’s everything you need to know.

What Is A Rent-to-Own Home?

Rent-to-own, a lease-option agreement, or lease-to-own: It goes by different names but describes the same thing. A rent-to-own house is an agreement that lets you rent a house and then eventually buy it from your landlord.

When you rent-to-own a home, part of your monthly payment is treated as rent and part of it is saved for a down payment.

A handful of big corporations back many rent-to-own homes in the United States, including Divvy, ZeroDown, Landis Technologies, Home Partners of America and Verbhouse.

How Does Rent-to-Own Work?

Here’s how the rent-to-own process usually works:

  1. You sign a contract with the person or company that owns the house. (A small down payment, deposit or fee is required).
  2. You rent back the home for a certain period, anywhere from one to five years.
  3. A portion of your rent payments are applied toward your future down payment.
  4. When your lease is up, you should be able to purchase the house from the company.

Remember: You only receive the deed after you buy the home. When you’re renting, the title of ownership belongs to the rent-to-own company.

You’ll also pay the owner a nonrefundable fee, called an option fee, which simply gives you the option to purchase the home down the road. The fee can range anywhere from 1% to 5% of the purchase price. (It may be applied to your down payment if you decide to buy the home later.)

Some landlords may also require first and last month’s rent before you move in.

If you decide not to buy the property at the end of your lease, you’ll lose the deposit and any money you put into the home via repairs.

Rent-to-own contracts vary. The agreement can either give you the option to buy or an obligation to buy after a certain time. It’s really important to know the difference.

  • Lease-option agreements: You can buy the home at the end of the lease — but you’re not required. You can walk away from the home at the end of the term without any obligation to buy or continue renting.
  • Lease-purchase agreements: You could be legally obligated to purchase the home at the end of the lease, even if you can’t afford it. Walking away could result in hefty fines or even a lawsuit.
Sometimes renting makes sense. Here are 10 things you should rent instead of buy.

Who’s the Target Audience for Rent-to-Own Homes?

Renting to own is targeted to people who may struggle to purchase a home otherwise.

This can include people:

  • who can’t afford a 5% to 10% down payment.
  • with credit scores below 720.
  • with high debt-to-income ratios.
  • who are gig workers, contract workers and others with inconsistent income.

Downsides of Rent-to-Own Houses

While it is possible to find a good deal, the entire rent-to-own marketplace has a bad reputation due to a history of scams, high fees and predatory practices.

Once you consider the costs of larger monthly rent payments and maintenance costs, you could end up paying more money than the home is worth.

Here are the drawbacks you should know about.

You Don’t Own the Home

These programs aren’t the same as buying your own home. It’s a much more complicated agreement. Like anything complex, the devil is in the details.

First, your entire rent payment is not applied to the eventual home purchase, so it’s not like you’re paying for the home over time. Part of your monthly payments are still rent money, which goes into your landlord’s pocket.

This makes rent-to-own homes often more expensive than renting a traditional home in the same area at fair market value.

While part of that monthly payment goes toward savings, you’re still responsible for securing the rest of the down payment and getting your finances in order so you can qualify for a mortgage.

There’s also no guarantee that you’ll get approved for a mortgage before your lease expires.

Maintenance and Repair Costs

Rent-to-own customers often pay a share of maintenance costs too, especially regular upkeep. You may also be on the hook for property taxes and HOA fees.

These additional costs make it more difficult to save for a mortgage down payment before your lease is up.

Hidden Terms

Rent-to-own contract terms almost always favor the owner, not the renter.

One late payment, for example, could cancel the deal. Or, you might be able to pay a fee to “get back on track” with payments, at which point you’re once again paying more money than you would as a traditional renter or a traditional homeowner.

What Happens If You Walk Away

Another downside? You’ll lose your initial deposit or option fee if you decide not to buy the house, which can total several thousand dollars. The company could even keep the portion of your monthly payments intended for a future down payment. Plus, you won’t get the extra money you put into home repairs or improvements if you decide to walk away.

If you entered into a lease-purchase agreement things can get really messy. Since you’re obligated under contract to purchase the home at a specific time, the owner can sue you if you’re unable to buy the property.

On the fence about buying a home? Here’s how to decide if it’s better to rent or buy.

6 Steps to Taking Before Buying a Rent-to-Own Home

Rent-to-own homes promote themselves as an affordable avenue to homeownership.

But the truth is, there’s a lot of expenses, and few rent-to-own agreements end in homeownership.

Divvy, a growing rent-to-own corporation, says about 40% of its renters have exercised their option to buy. Home Partners of America claims a 45% renter-to-homeowner conversion rate, according to a July 2022 report from Moody Analytics.

In short, less than half of people who enter these agreements end up buying a home. Those aren’t great odds.

Here’s what to watch out for when considering a rent-to-own home.

1. Understand the Rent-to-Own Agreement

Rent-to-own contracts include two distinct parts:

  • The rental agreement, which outlines the terms you need to follow as a renter, just like any other lease.
  • The purchase agreement, which outlines the terms under which you agree to eventually buy the home.

Make sure you’re clear on both the rental and purchase agreement terms. Ask the owner these questions if they’re not clearly stated in the contracts:

  • Who will handle maintenance, repairs and improvements to the property?
  • What happens if you miss a payment?
  • How is the purchase price of the home calculated?

2. Understand the Home’s Purchase Price

Many rent-to-own agreements state the home purchase price up front.

The price could be based on the home’s current value or what the property might be worth in the future. For example, the seller could write the contract so the purchase price in five years is $30,000 more than it is today.

On the other hand, a rent-to-own agreement can let the buyer and seller set the purchase price after the agreement is signed but before the lease expires.

3. Make Sure You’re Ready for a Mortgage

Unless you can save up enough money during your lease to buy the home outright, you’ll need to qualify for a mortgage.

After all, the money you paid as a renter will likely only cover part of a down payment.

Here’s an example.

  • You enter a rent-to-own agreement on a house valued at $275,000. Your lease agreement is for two years.
  • Your monthly rent payment is $2,000.
  • 20% of that payment ($400) goes toward saving for a down payment each month (also called a rent credit).
  • At the end of your two-year lease, you’ll have a $9,600 rent credit saved.

To qualify for a 10% mortgage down payment, you’ll need $27,500. If you’re a first-time homebuyer, you could qualify for a 5% down payment, but you’d still need $13,750 — $4,150 more than you’ve saved in rent credits.

Your initial deposit or option fee might get credited to your down payment, which can help. But again, this all depends on the details of your specific rent-to-own agreement.

Before you sign, be realistic about how large of a monthly payment you can afford. And make sure you understand how large the down payment will be when it comes time to purchase the property.

How much house can you afford? Here’s how to do the math.

4. Talk to a Real Estate Agent or Attorney

Rent-to-own agreements are dense and complicated. You’ll need help from an independent real estate agent or an attorney to understand your rights and responsibilities.

A legal expert can identify clauses in a rent-to-own agreement that could prevent you from easily purchasing the home down the road.

For example, something as minor as a late rent check or not paying for a repair in a “timely manner” could mean the deal is off, and the landlord is no longer obligated to honor the agreement.

An attorney can help you identify these loopholes so you can hopefully negotiate more favorable terms with the owner before you sign.

5. Research the Property and the Seller

Rent-to-own homes are often marketed as “fixer-uppers.” Even if the house seems in good shape, do your due diligence.

It’s wise to order an independent appraisal, obtain a property inspection, ensure there’s no liens on the house and property taxes are up to date.

Look into the company that owns the home, too. Does it have a good track record of converting renters to owners? Or is it nearly impossible to find information about the owner? If it’s the latter, that’s a huge red flag.

You can look up property records on your county’s clerk of courts or appraiser’s website. Make sure the current owner is the person or company you’re signing a contract with.

6. Get Your Finances in Order

If poor credit is holding you back from purchasing a home the traditional way, meet with a couple mortgage lenders during your lease to learn what steps you need to take to qualify.

If you can’t qualify for a mortgage today due to poor credit or a high debt-to-income ratio, those same barriers will prevent you from doing so in the future —- unless you take action.

Meeting with a credit counselor or financial advisor before your lease expires is a good way to create a budget and improve your credit score.

Take steps today to build a good credit score. Here are 10 ways to make your credit score soar this year.

Alternatives to Rent-to-Own

Rent-to-own programs are tempting if you want to own a home but aren’t able to do so due to your current financial situation.

But it’s not your only option. Here are some alternatives to rent-to-own homes:

  • Explore first-time homebuyer programs in your state that can help with a down payment and closing costs. These government programs can also help you lock in more competitive mortgage rates.
  • Several big banks, including Chase and Bank of America, are offering zero-down mortgage programs in minority communities. You might qualify for one of those.
  • Consider getting someone, like a parent, to co-sign the mortgage with you.
  • Work with a credit counselor or financial advisor to create a roadmap of what it will take to get a traditional mortgage.

Buying a home is a great way to build wealth. But entering a rent-to-own agreement can turn your homeownership dreams into a nightmare. You’re likely better off saving money for a down payment on your own — not forking extra money over to a landlord.

Rachel Christian is a Certified Educator in Personal Finance and a senior writer for The Penny Hoarder. She focuses on retirement, credit scores, investing and life insurance.