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Founder, CFP® Joel Ohman

UPDATED: Apr 15, 2021

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A rent-to-own home (also called a lease-to-own home) is a home that, after renters pay a certain amount each month to live in the house, presents the renters with the option to purchase the home. Aside from the option to buy, a portion of each month’s rent payment is put towards a down payment upon the home as well.

For some sellers and buyers, rent-to-own homes might not always be the right decision, but that can be determined by examining how rent-to-own home purchases work and how they differ from borrowing a traditional home loan.

How Rent-to-Own Works

Rent-to-own home purchases work very similarly to car leases.

Todd Huettner, Mortgage Broker for Huettner Capital, told that renting-to-own is actually very attractive for buyers and sellers, provided they get the process right.

“You must have an agreement in writing that clearly defines the agreement, including a price, equity earned from monthly payments, and any deadlines,” he said. “Rent-to-own is simply seller financing for a purchase and should be treated as such. Therefore, you must realize you are a buyer and your landlord is the seller.”

In the event the seller chooses to provide the borrower with financing, the purchase agreement may be for 15 or 30 years, just like a traditional mortgage loan.

Huettner said that one popular way to structure a rent-to-own agreement is with a contract for a deed or a contract for real estate.

“This is simply an agreement to transfer ownership of property between a seller and buyer,” he said. “Essentially, it is a purchase contract that takes years to close instead of 30 to 60 days. The buyer may pay the seller a down payment and then pays monthly payments. If the buyer meets the agreement’s requirements, the seller then gives the buyer the deed to the property.”

However, if the buyer does not pay as agreed or does not meet other requirements of the agreement, the seller can reclaim the property. This is possible because the seller stays on the title while the buyer gains equitable interest in the property.

“Your agreement may be for 15 or 30 years of fully paying off the seller or it may be an agreement for a few years when you must get a loan to pay the seller the rest of what you owe,” said Huettner.

Either way, buyers ought to create a plan and timeline that details exactly how and when they will pay off the seller. Buyers need to know how they will secure traditional financing and include alternative options in the event the initial plan is unsuccessful.

As with most important financial arrangements, Huettner advises anyone interested in rent-to-own homes to consult with an attorney and other real estate professionals including an appraiser and title company.

“You will need to ask the attorney about specific state and local laws, including usury limits,” he said. “Also, to avoid payment disputes and have a third-party document your payment history, use an escrow service to handle all payments including making the taxes and insurance. Escrow companies will also hold the documents related to the transaction.”

Buyers and sellers are advised not to “reinvent the wheel.” Instead, they should structure rent-to-own transactions to mimic more traditional home purchases by using written contracts, appraisals, surveys, title policies, and by recording appropriate documents.

“Doing so uses industry standards that protect the buyer and seller using industry standards that most people understand,” said Huettner.

With all that said, interested buyers and sellers can better decide if rent-to-own is their “cup of tea” by comparing it to a traditional mortgage loan-backed home purchase.

Rent-to-Own versus Traditional Mortgage Loans

T.C. Strait, Co-Owner and Loan Officer at Lynx Financial Group, told that there are only three notable differences between a traditional purchase mortgage transaction and a rent-to-own transaction:

  1. Time
  2. Deposits and downpayments
  3. Credit scores

Creating and structuring rent-to-own home agreements usually takes much longer than traditional financing arrangements. In traditional mortgage loan purchases, the term of contract is completed between 30 to 60 days. In rent-to-own transactions it would typically be for a period of 6 to 24 months, whereupon a buyers will usually go through a traditional purchase with a mortgage loan at the end of the multi-month period.

When it comes to deposits, rent-to-own and traditional mortgage loans operate very differently. Generally a traditional mortgage transaction would involve a buyer giving the seller an Earnest Money Deposit that the buyer gets credited back to them upon closing on the purchase. In rent-to-own transactions, the deposit is generally more, and is given upfront or occasionally on the one-year anniversary of the rent-to-own contract. Rent-to-own deposits are often credited back to the buyer when they purchase the home by using a traditional mortgage loan, or more rarely a cash purchase.

Receiving credit for downpayments is one of the biggest appeals of rent-to-own homes. Quite often, buyers and sellers will write up the rent-to-own contract that specifies that the buyer will get a certain dollar amount of the rent that is paid each month that gets credited towards the eventual home purchase. For instance, the seller may specify that $200 of each month’s rent payment will be credited to the buyer at the time they purchase the home using a mortgage loan.

What the buyers and sellers often don’t realize is that the buyer can only receive a credit for any amount of rent paid that is more than “fair market rent” as determined by the appraiser.  For instance, if the appraiser notes that the “fair market rent” for the property is $1000 per month, and rent-to-own contract states the buyers rent is $1000 per month, the buyer cannot receive any credit for rent paid. As you can imagine, this can be a costly technicality that brings buyers no closer to their goal of purchasing the home.

Finally, credit scores tend to matter less in rent-to-own contracts than in traditional mortgage loan agreements.

“I’ve had many clients opt to go the rent-to-own route because they wanted to buy now, but their credit score was slightly under the minimum score required,” said Strait.  “I’ve also had clients that had a bankruptcy that was less than two years old, but with otherwise good credit, opt to go the rent-to-own route.”