How do rent-to-own homes work?

by Elizabeth Rosen, Contributor

Rent-to-own is a type of homeownership option that has been growing in popularity. Generally considered a good option for first-time home buyers, or home buyers with a tight budget, renting to own helps remove the barriers that prevent many people from owning a home.

The concept of rent-to-own is known by several other names, including lease-to-own, lease option, and owner-financed. It allows you to gradually enter into homeownership without breaking your monthly budget. Renting to own also helps you avoid having to come up with a large down payment or paying property taxes right away.

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Keep in mind that in reality, no two rent-to-own transactions will be exactly the same since every home seller is unique. However there are some significant concepts that make up a rent-to-own agreement which are important to understand if you are considering this path to homeownership.

The basics of renting to own

There are two major components to a rent-to-own agreement. The first component is the Standard Lease, which states the monthly rent payment and other lease terms. The second component is the Purchase Option, which allows the renter/buyer to purchase the home at the end of the lease, at a previously agreed upon price (given that the buyer has properly followed the terms of the agreement).

There are generally two main parties that enter into a rent-to-own transaction:

Tenant-Buyer — The person who will be renting and living in the home, with the opportunity to purchase the home at the end of the lease term.

Landlord-Seller — The person wants to sell their home and will enter into a lease agreement with a tenant-buyer.

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The lease term for a rent-to-own agreement is typically twelve to thirty-six months. Once the lease term is over, the tenant has the option to buy the home for a predetermined price.

Note that you are not obligated to purchase the home after the rental term has ended. The landlord-seller will give you the option to buy, but the final decision is yours.

The elements of a rent-to-own transaction:

While the details of each rent-to-own contract are unique to the tenant-buyer and landlord-seller involved in the transaction, you can still prepare for the process by understanding the basic elements.

There are six key components in a rent-to-own agreement:

1. Lease Signing — Once you have found the right home, you will need to prepare an offer and go over the terms of the contract with the seller. As with any major financial transaction, it’s recommended that you have a lawyer present to ensure that you completely understand the agreement and everything goes smoothly.

2. Upfront Deposit — Depending on the terms of your rent-to-own contract, you may need to come up with a small down payment or other deposit to secure your stake in the property. Your down payment will become non-refundable as soon as the appropriate inspections are made and you move into the home.

3. Inspection Period — Once the tenant-buyer and the landlord-seller have signed the rent-to-own contract, the renter can do several things to make sure the property is in good condition. These include getting a professional home inspection, performing a title search, and requesting a market valuation study. Once you know that things are in order, you can move into the home and begin the rental term.

4. Rental Term — Your lease term may be anywhere from 12 to 36 months, depending on the details of your agreement. During this period, you will be making monthly rental payments to the landlord-seller.

5. Monthly Rent Credit — Meanwhile, during the rental period, you will also be earning “rent credit” each month (calculated as a portion of your monthly rent payment) which will accumulate in an escrow account until your buy the home. Note that rent credit is non-refundable if you choose NOT to purchase the home at the end of the lease term.

6. Purchase Price — Once the rental term is over, and both parties have complied with the terms of the agreement, the tenant has the option to buy the home they’ve been living in. The purchase price will have already been determined in the beginning of the rent-to-own process, when all other terms of the contract were laid out. If you decide to buy the home, you will work with a mortgage lender to set up a mortgage loan. You will also need to prepare a Purchase Agreement for the landlord-seller, which both you and the seller must sign.