What Is Rent-To-Own And How Does It Work?

Those looking to buy a home in the past few years have faced a challenging market. While listings and available homes have decreased, interest rates and home prices have risen dramatically, causing affordability to become historically challenged. Meanwhile, demand has stayed high, making it substantially more difficult to purchase a home. Because of this, a new pathway to homeownership has been growing in popularity that provides a hybrid approach, allowing you to enjoy the benefits of both renting and owning: Rent-to-own homes.

Rent-to-own can be a great option if you’re working on your credit score or want to get to know the area before committing to a traditional purchase. There is more involved than a typical rental lease, so it’s important to understand the details of this alternative before getting started.

Keep reading for an in-depth walk-through of rent-to-own, covering everything from what it is, how it works, and the steps involved.

Table of Contents:

1. What is a Rent-to-Own Home?
2. How Do Rent-to-Own Homes Work?
3. Types of Rent-to-Own Home Agreements
4. How to Buy a Rent-to-Own Home
5. Who is Rent-to-Own Best For?
6. Rent-to-Own Home FAQs

What is a Rent-to-Own Home?

Rent-to-own homes allow you to move in and occupy the house as a rental tenant while also having the option to purchase the home at a set price in the future. You make normal rent payments each month, and some programs include an additional monthly savings that would be applied to the purchase price if you decide to buy. When it comes time to buy, you purchase from the rent-to-own company at an agreed-upon price, eliminating bidding wars and outside offers that unexpectedly drive the price up, as well as putting you in control of the timing of your future purchase.

How Do Rent-to-Own Homes Work?

Rent-to-own home programs typically have two primary documents: the Lease Agreement and the Option Contract.

The Lease Agreement

This operates as a typical lease that outlines your monthly rent, fees, and what you can and cannot do with the property. Always review your lease before signing to ensure you fully understand your obligations as a tenant and the company’s obligations as the property owner.

The Option Contract

This document gives you the ability to purchase the home, which makes a rent-to-own home different from a traditional rental. Key points to review in the option contract include:

Minimum Tenancy Requirements: The minimum amount of time you must rent before purchasing and the window of time in which you can purchase.

Home Purchase Price: Most reputable rent-to-own companies display the fixed purchase price, and any rent increases with each renewal of the lease, typically every 1-2 years.

Option Fee: Some programs require an extra deposit to secure the option of buying the home. This fee typically goes towards the final price if you choose to purchase and is nonrefundable if you walk away. Option fees normally range from 1% to 5% of the purchase price.

Types of Rent-to-Own Home Agreements

The viability of rent-to-own as an alternative to traditional home-buying depends on the fine print. There are two types of agreements that typically get lumped under “rent-to-own.” Although very similar, it is critical to distinguish between the two.

Lease Option

With a lease-option contract, you have the right, but not the obligation, to purchase the home. Under this agreement, you may have to rent for a certain period of time and wait until the lease ends to exercise your purchase option. Some sellers add an option fee that must be paid upfront. If you decide not to purchase the home, the option will simply expire, and you can walk away from the deal.

This agreement is generally better for the person renting to own because it allows you to enjoy the flexibility of renting and the ability to walk away if plans change.

Lease Purchase

With a lease-purchase contract, you have a legal obligation to purchase the home. These agreements state that after the lease ends(commonly 12-36 months, but negotiated on a per-deal basis), you must purchase the house. These agreements have lower upfront/option fees, and typically a portion of your rent goes toward the down payment, but at the expense of your flexibility as a buyer. It is crucial to get an inspection and conduct due diligence as if you were buying the home outright when entering this type of agreement.

Lease-Option Versus Lease-Purchase

While there are pros and cons to each agreement, we typically see lease-option as the better agreement for the consumer. It allows you to enjoy the flexibility of renting and the ability to walk away if plans change.

In contrast, a lease-purchase requires you to buy the home regardless of any changes in your situation, sometimes with heavy penalties if you cannot finance the home. It’s always a good idea to review the agreements closely to make sure you know which type of contract is being offered.

How to Buy a Rent-to-Own Home

While the documents involved may seem complex, the process of buying a rent-to-own home is fairly simple and can be broken down into six steps:

1. Find a Trusted Company

When choosing rent-to-own, start by selecting a company to work with. They will be heavily involved in your experience, from move-in to property management and your eventual purchase of the home, so it pays to do research before getting attached to a home. Check their policies around purchasing the home, and if they’re upfront about the rent payment and home price.

Clarity and transparency should be important factors in your decision-making. Take note of their customer service and support team to see if they’re actively helping and preparing you to purchase the home once you move in. These companies should have an application process so you can find out what you are eligible for.

These days, the homes are typically already owned by the company. An additional benefit to starting by vetting a company first is that you’ll gain access to their team’s experience in analyzing and inspecting homes.

Our acquisition and asset management team has decades of experience providing homes to our customers. They know exactly what to look for and rigorously inspect each home to make sure there are no hidden surprises and will serve our customers for years to come.  

2. Find a Rent-to-Own Home

You can typically find a rent-to-own home and avoid scams by working directly with the company you’ve already vetted. They often have in-house agents who can guide you through the process and find a home that meets your criteria and is eligible for their rent-to-own program.

3. Review The Agreement

Once you’ve decided on a home, review the rent-to-own agreement, which includes the lease and purchase option contracts. This step is critical to ensuring you have a solid plan to move forward. Make sure the agreement is what you were expecting, e.g., lease-option vs. lease-purchase. Review the upfront costs, monthly rent, and any additional fees that may apply. Lastly, check the purchase price for the home. This will give you a clear goal to prepare for while you rent.

Rent-to-Own Contracts: Before You Sign

Ensure you’re on the same page with the company before entering into the rent-to-own agreement. Here are some key questions to ask:

• Who is responsible for minor repairs?
• Who is responsible for major repairs?
• What will property management look like for this home while I’m renting?
• What is the purchase price of the home each year, and how many years do I have?
• What will my monthly rent be, and how much are the increases each year?
• Am I able to purchase mid-lease?
• What homeownership resources do you offer to help me prepare?

We answer these and other commonly asked questions about Pathway in our FAQ Guide.

4. Sign The Agreement and Move In

Once you’ve reviewed and decided to move forward, sign your agreement and move in. This is typically when any upfront costs are due, such as move-in fees and option fees. Then, move in and turn the house into your home! Rent-to-own homes are typically more lenient with modifications since you plan to purchase it in a few years.

5. Prepare for Homeownership

Most reputable rent-to-own companies will cover large maintenance issues, property taxes, and other homeownership fees, allowing you to benefit from lower monthly costs and save for the home.

One of the best benefits of renting to own is that it gives you time to prepare financially and test the neighborhood before owning. Our customers recommend having a plan from day one to prepare to buy. During your lease, here are a few things you should prioritize:

Save for the Down Payment: Based on the purchase price and your plan to finance the home, determine how much you’ll need to save to buy it. Consider automatic savings deductions from your paycheck to ensure you have enough saved up by the time you can purchase. 

Work On Your Credit Score: With the plan of buying the house at the end of the lease (typically 1-2 years), take steps to improve your credit in preparation for a mortgage. At Pathway, we have several partnerships that help you enhance your credit and pay down debt.

“Test Drive” the Home: Once you’re settled, review the house every couple of months to ensure it meets your needs. Can you see yourself as the owner of the home?

Get to Know the Neighborhood: Renting gives you time to get to know the neighborhood before owning the home. Check out the local restaurants, shopping, and amenities nearby. Is this somewhere you’d love to be longer-term?

Keep track of these priorities so that you feel confident about your decision once it’s time to choose to purchase or keep renting!

6. Buy The Home

You’ve had the chance to try out the home and neighborhood. You’ve worked on your credit, you’ve saved the down payment, and you decide to buy the home and make it yours! 

Each rent-to-own company will have different steps surrounding the purchase process, which should all be described in your agreement. A few steps will happen with any provider you choose:

Notify The Company: The company will need notice in advance of your intent to buy the home. At Pathway, we only need 60 days, and you can notify us any time after two years, even mid-lease.

Secure Financing: Now that you’re buying the home, shop around and apply for a mortgage. If you don’t have a preferred lender, the rent-to-own company you partner with may be able to help in the search process.

Work With the Company to Buy the Home: Since buying a home can be a complicated process, it’s important to vet the company beforehand to make sure this goes smoothly. Companies with strong customer support will help you through this process. 

Once these steps are completed and the deed is yours, congratulations! You now own the home. Enjoy the full benefits of homeownership, like stable payments, building equity, and creating a legacy.

Who is Rent-To-Own Best For?

While rent-to-own can be a valid option for any aspiring homeowner, we typically recommend traditional financing if you qualify for it, especially if you’re able to put down a 20% down payment to avoid Private Mortgage Insurance (PMI). However, there are several situations where rent-to-own can be preferred over the traditional route of buying a home.

You Need Time to Save for a Down Payment: If you’re looking to move towards homeownership but still need time to build a downpayment, rent-to-own can be an excellent choice. It allows you to find a home you love and save for the down payment while getting settled. Plus, you won’t have to move again once you buy the home, compared to saving while living in a traditional rental.

You’re Working on Building Credit: Rent-to-own gives you extra time to work on your credit while securing and living in a home you love. At Pathway, we work alongside you to help build credit by providing partnerships and reporting on-time rent payments to the credit bureaus for a positive impact on your credit.

You Need Time to Build Income History: If you’re wanting to buy a home but recently had a change in employment, or you’re self-employed with less than 2 years of tax returns, it may make it more difficult to qualify for a loan. Most lenders want to see 2 years of steady employment when deciding your eligibility for a mortgage. Most rent-to-own companies only require around 3 months of income history, like a traditional rental. Then you can build income history while living in the house you’re planning to buy. We only need 1 month of income history, or your last two paystubs.

You Just Moved to the Area: Buying a house in a new market can come with uncertainties. You may not know the area well, and it takes time to really know a neighborhood. Rent-to-own gives you time to get to know your neighbors, community, shopping, restaurants, and schools before committing.

You Want More Peace of Mind: Buying a house is a huge investment, so you want to make sure you get it right. Living where you plan to buy for a few years can give you peace of mind and certainty about purchasing the home. By being able to “test drive” the home and neighborhood, you can purchase the home with confidence. Plus, you know exactly how much you’ll need to pay to own it, instead of competing with other offers to secure the home.

Final Thoughts

Rent-to-own gives you the unique opportunity to test out a home before buying and allows for more time to prepare for homeownership. If you’re new to an area, working on your credit, or struggling with traditional financing, you may benefit from this path to homeownership!

If you have additional rent-to-own questions, we’d be happy to help! Give us a call at (877) 958-1888 or email us at hello@yourpathway.com to receive more information on this new way to buy a home. Enjoy the flexibility of renting and the stability of homeownership with Pathway Homes.