Rent-to-Own Homes: How It Works

What Is a Rent-to-Own Home?

A rent-to-own agreement can give you the option to buy the home for an agreed-upon price at the end of your lease term. This sets it apart from a regular rental agreement, which typically requires an upfront security deposit and lasts for a set time period—generally six months to a year or longer. You can renew your contract when your lease ends, which might involve a rent increase, or move out. As a renter, you never have an ownership stake in the property. On the other hand, rent-to-own agreements assume you will eventually purchase the house.

How Does Rent-to-Own Work?

With a rent-to-own home, instead of making a security deposit upfront, you'll pay a nonrefundable option fee. This can range anywhere from 2% to 7% of the home's value. You can put this amount toward the purchase price if you end up buying the home later on.

You'll then make monthly rent payments, which may be higher than what you'd pay with a regular rental agreement. That's because a percentage of each payment may be directed to an escrow account that grows over time. In this case, you can draw on those funds to cover some or all of your down payment—but you'll still need to qualify for a mortgage when it comes time to finalize the home sale. The rental period typically lasts one to three years.

Types of Rent-to-Own Agreements

There are two main types of rent-to-own contracts: a lease option and a lease purchase.

Pros and Cons of Rent-to-Own

Entering into a rent-to-own agreement comes with advantages and downsides. It's wise to consider the following before signing.

Is Rent-to-Own a Good Idea?

Whether rent-to-own is the best option for you will depend on your financial situation and homeownership goals.

When Rent-to-Own Might Make Sense

• You need time to save a down payment.
• You want to improve your credit score before applying for a mortgage.
• You don't mind paying the option fee and higher rent payments.
• You've found a rent-to-own home that feels right and is in your budget.

When Rent-to-Own May Not Be the Right Fit

• You already have strong credit, income and savings—meaning that you'd likely qualify for a mortgage on your own.
• You're not sure where you want to live.
• Covering the option fee and higher rent payments would stretch your budget.

How to Buy a Rent-to-Own Home

Here's a step-by-step guide to buying a rent-to-own property.

1. Review Your Finances

Look over your budget and decide how much you can afford to spend on the option fee, monthly rent payments and eventual purchase price. You'll also need to cover closing costs on your mortgage, which typically range from 2% to 5% of the sale price. Knowing your numbers can help you better navigate the rent-to-own process.

2. Look for Properties

Rent-to-own homes may be available from individual homeowners or rent-to-own companies. Here are a few ways to find potential properties:

• Ask a trusted real estate agent
• Look on sites like Zillow or Redfin for local rent-to-own properties
• Research large rent-to-own companies like Divvy or Dream America

3. Negotiate With the Owner

Before entering into a rent-to-own agreement, you'll work with the homeowner to agree on the following details:

• Type of rent-to-own agreement (lease option or lease purchase)
• Option fee
• Length of the rental period
• Monthly rent payments
• Final sale price

You'll also determine who will be responsible for maintaining the home and paying for homeowners insurance and property taxes. A real estate attorney can be a helpful resource here. If everything looks good, you can sign on the dotted line and pay your option fee.

4. Move in and Begin Paying Rent

You'll make monthly rent payments for a predetermined amount of time. You can use this time to strengthen your credit and build your savings. As your rental period draws to a close, you can begin preparing to apply for a mortgage.

5. Secure a Home Loan

Consider getting preapproved for a mortgage and comparing rates and terms from multiple lenders. Shopping around can help you find the best home loan. Once you've secured financing, you can finalize the home sale.

Alternatives to Rent-to-Own

Rent-to-own homes aren't for everyone. You can consider these alternatives if you decide it isn't right for you:

• Homebuyer assistance programs: Check with your state to see if you qualify for any first-time homebuyer programs. That may include loans or grants to put toward your down payment or closing costs.
• Government-backed mortgages: Home loans that are insured by the federal government typically have looser eligibility and down payment requirements. That might make it easier to get approved.
• Continuing to rent while saving for a down payment: You can save for your down payment and take steps to improve your credit on your own timeline. Once you're ready, you can seek mortgage preapproval and start house hunting.

Learn more: How to Save for a House

Frequently Asked Questions

The Bottom Line

Rent-to-own homes offer an alternative path to homeownership. It could be a good option for folks who want time to build their credit and savings before applying for a mortgage. But you can expect upfront fees—and you may be responsible for maintaining the home and paying for homeowners insurance and property taxes during the rental period.

Your credit health will be an important factor whether you pursue rent-to-own or apply directly for a mortgage. You can start by checking your FICO^® Score^☉ and credit report for free from Experian.