4 Ways Rent-to-Own Can Help You Buy a House

Rent-to-own agreements come back into vogue as interest rates rise.

Although home prices in some regions of the country have softened, the median price of a single-family home still rings in at just under $385,000. With mortgage rates hovering around 7%, the monthly payment alone pushes many would-be home buyers out of the market. For those buyers, an alternative like rent-to-own may be worth a look. Here, we outline how rent-to-own works, how it can help buyers get into a home now, and a few red flags to be aware of.

What is rent-to-own?

Rent-to-own, sometimes referred to as a "lease option to purchase,” is an agreement in which you rent a home for a set period of time with the option of buying it when your lease expires. While the lease is active, part of each rent payment goes toward a down payment on the house.

4 ways rent-to-own can help you buy a house

For some, rent-to-own represents an alternative way to buy a home. Here's how it could work for you.

1. Approval may not be as stringent

If your credit score is not up to snuff but you desperately want to buy a home, a rent-to-home arrangement may be easier to qualify for than a traditional mortgage. In fact, the seller may not even run a credit check. That's because they know that if you later decide you don't want to buy the home or cannot qualify for a traditional loan, they get to keep an option fee collected as well as the rent credits collected each month (more on those in a moment). 

2. Rent-to-own buys you time

Let's say you sign a three-year lease. That gives you 36 months to get your credit score in shape. It also gives you time to save more money for the eventual purchase of the home. 

3. It's all negotiable

Everything about rent-to-own is negotiable. You work with the seller to determine things like whether there will be an option fee due and which party will pay for repairs to the home (the costs are typically split). 

A rent-to-own deal involves dozens of details, but they're all things you can negotiate in your favor. In addition, hiring a real estate attorney to look over the contract before signing further protects your interests. 

4. May lock in your price

If you live in an area of the country where home prices never seem to decrease, locking in a sales price at the beginning of your lease means not having to worry about what the market is going to do over the next few years. Peace of mind frees you up to focus on what's important -- like paying down debt and saving money. 

This fact cannot be overstated: There is rarely a real estate agent involved in a rent-to-own situation. And if there is a real estate agent, they normally represent the seller. As the buyer, it's up to you to carefully check the details of the agreement and hire a professional to make suggestions.

How it works

Let's say you find a neighborhood you like and a homeowner willing to enter a rent-to-own arrangement. The process plays out like this: 

• You'll tentatively agree upon terms. One of those terms involves whether you'll agree to the sale price now or when your lease ends. There are pros and cons to both. If you agree on a price now, you don't have to worry if the value of the home increases over the term of your lease. If you wait to agree on a price, it's possible the value of the home will decrease and you'll snag a better deal.
• Learn if an option fee is required. This is also called "option money" or an "option consideration." If the seller requires the fee, you'll need to pony up the money when you sign the lease. An option fee typically lands between 2.5% and 7% of the value of the home. Let's say the current value of the home is $200,000. That means the option fee could run between $5,000 and $14,000.

One note about the option fee: The option fee may, or may not, go toward the price of the home. If it does not, you may want to walk away. Naturally, the owner wants to keep the money but it's in your best interest to ensure it goes toward your down payment if you do decide to buy. This is only one example of why you want to hire a real estate attorney to look over the contract before signing.

• You'll also want to contact a mortgage lender. Since you want both your option fee (if you pay one) and part of each monthly payment to go toward the down payment, you'll need to ask a mortgage lender the best way to structure the down payment so you don't run into problems securing a mortgage loan when you're ready. Some lenders are nervous about approving a loan when the down payment was paid as part of rent and it can help to have a lender on board before entering into the lease.
• Once the details are ironed out, you'll sign a lease lasting from one to three years (or longer if you agree upon it). 
• Each month, you will pay more than other renters in the area, but part of each payment goes toward the down payment. For example, while others are paying $2,000 per month, you may be paying $2,300, $300 of which goes into a down payment fund. After one year, there will be $3,600 in the fund and after three years there will be $10,800. If you've also paid an option fee, hopefully you've structured the contract so it also goes toward your down payment. 

Even if you totally fall in love with a home, it's okay to walk away from any deal that does not benefit you financially. While rent-to-own homes don't hit the market often, it's worth it to wait for the right one.