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How does rent to own work when buying a house?

The Complete Guide to Rent to Own Houses

An Overview of the Rent to Own Process

When it comes time to consider purchasing your home, a viable option for many people is the rent-to-own (RTO) option. This practice is gaining favor with young people and families who may not have the means or the credit to secure a mortgage loan. This article will go in-depth on the topic of the rent-to-own real estate option. We'll talk about how it works when it's a good idea, why sellers opt for this type of sale, how it compares to buying a home, pros, cons, and much more. The goal of this article is to give anyone who wants more information about RTO a complete overview, plus links to find out more information. By the end, you should have a good idea if this option could work for you or not.

Alternatives to Renting-to-Own

If purchasing a house under an RTO contract doesn't seem like an appealing process to you, there are other options to consider.

Alternative Loans

It might not be possible for you to qualify for a traditional loan, but there are alternative home loans that are more flexible with their stipulations. The USDA home loan or the FHA loan may be able to qualify you for a mortgage. Both have lower income, down payment & credit score requirements than conforming mortgages.

Clean up Your Credit

While you're renting your home, you can take steps to clean up your credit. This will take time, but it is possible to raise your credit score enough that you'll qualify for good mortgage rates. You can catch up on any delinquent payments, pay down your balances, consolidate debts, stay current on everything, and use any credit cards you have responsibly.

Save While Renting

You may not want to rent forever, but it can give you the stability to save up for a down payment. You know what you have to pay each month, and this makes budgeting easier. You'll be able to put aside more money every month, and this can help you save for expenses.

Rent and Buy.

Here is a table of current local mortgage rates which shows available rates for different home prices, down payment amounts & credit scores.

How to Rent to Own Works

When you enter an RTO contract, you agree to rent the property for a set amount of time and purchase it once the contract term is up. There is more flexibility in this option, and you usually won't need a large down payment like you would if you were purchasing a home. Many RTO contracts have a term of one to three years. This means that after that set term is up, the tenant will purchase the property from the seller. You'll usually pay a higher rent amount because your rent will be split into two categories. The rent portion of your monthly payment will go toward the seller's mortgage payment on the home, and the rent premium portion will go into an escrow account and be used for the down payment when it comes time to purchase the property.

How Common is RTO?

In April of 2000 the FTC released the results to a survey of 12,000 randomly selected U.S. rent to own customers. This survey represents people who purchased any type of product rent to own industry. Most of the purchases were for home electronics, furniture & appliances. While the purchase prices are far smaller than the cost of a home, many of the concerns are similar to those who are renting a home.

Description Statistic
Prevalence
used RTO past year 2.3%
used RTO past 5 years 4.9%
Consumer Satisfaction
satisfied with experience 75%
dissatisfied with experience 19%
leading complaint high prices
Success Rate
intended to buy when beginning process 67%
actual purchase rate 70%
intended to purchase & did buy 87%
Late Payments
made a late payment nearly half
fair to very good treatment after late payment 84%
poor treatment & possible abusive collections 11%

The entire report is available for download as a PDF here.

Some rent-to-own shops charge fees & interest which amount to over a 300% mark up over retail. The spreads on rent-to-own homes are typically far tighter, simply because the amount being financed is much higher. That said, the success rates for rent-to-own homes are likely much lower than they are for other types of goods, as the contract both lasts for a longer period of time and is associated with a far larger sum of capital.

Rent to own homes were a popular option in the 1980s & 1990s, but receeded in popularity during the housing bubble as lending standards weakened to where almost anybody with a pulse could "qualify" for a mortgage.

“In mid-2006, I discovered that over 60 percent of these mortgages purchased and sold were defective. Defective mortgages increased during 2007 to over 80 percent of production.”
- Richard M. Bowen, former chief underwriter for Citigroup’s consumer-lending group

Banks got bailed out, mortgage lending standards tightened, and investors scooped up many discount properties from Fannie Mae, Freddie Mac & HUD for pennies on the dollar.

Some of those properties moved into the RTO market, and with tigher consumer lending standards, RTO is once again becoming a popular option.

The exact size of the market is unknown because failed deals are not recorded & successful transactions are not reported on until the property is fully owned by the new owner.

Things to Consider in Your RTO Contract

House Purchase Contract.

RTO contracts and conditions vary from state to state. However, there are several factors that are almost universal between all of the contracts, no matter when state you're purchasing the property in.

  • Buying the Property. Once the term is up if the potential buyer decides or isn't able to buy the home, the RTO offer expires. The buyer will forfeit any money they have paid in, including option money and rent. If there is a legal obligation to purchase the property and the buyer forfeits, court proceedings may begin. At the end of the RTO term, if the tenant wants to buy the property, they usually apply for a mortgage. They may deduct the option money and any rent they have paid in so far from the total purchase price.
  • Maintenance. Usually, there are specifications in the contract concerning maintenance. It isn't uncommon for the person who is purchasing the property to maintain it while they're living there. The tenant can be asked to pay for any repairs, property taxes, insurance, and any homeowner's association fees. Since it is the seller's home, they are technically responsible for taxes, insurance, and homeowner's association fees but they could ask the tenant to pay them. Either way, the tenant will need renter's insurance. It is up to the potential seller to specify what is covered by maintenance and what is not covered. This is very important because if nothing is specified, the tenant could end of doing major repairs instead of basic maintenance.
  • Option Consideration. With these types of contracts, the potential buyer may have to pay the seller a one-time deposit. This deposit is called an option consideration or option money, and it usually isn't refundable. This deposit gives the potential buyer a right to purchase the property, and not an obligation. The size of the option consideration isn't set, and it can be negotiated by the buyer and seller. Traditionally, it is between 2% and 7.5% with 3% being a popular option of the purchase price. You may also negotiate to have the consideration price onto the purchase price when you close the deal and buy the property.
  • Price. Your price is what the seller and the tenant have agreed on to buy and sell the property for. This purchase price is usually above the home's current market value. You can choose to have a set rate, or you can choose to decide a purchase price based on market values once your payment term is up. As the real estate market isn't guaranteed, many sellers opt for a fixed rate price.
  • Rent. While the potential buyer is living in the home during the set term, they are paying rent. A percentage of the rent will typically go toward the purchase price, and this is called a rent credit. It is vital rent is paid on time or else the buyer may not get rental credit & may be assigned a fine. To understand how rental credit works, let us consider a $225,000 RTO property with a 3% option consideration. This will give you a $6,750 option consideration that can be credited toward the purchase price. The rent payments are $1,550 each month with $300 earmarked as a rent credit. The RTO term is 24 months until you have to purchase the home. If you take all of these things into consideration, you get:
RTO Example Amount
Locked in Purchase Price $225,000
Option Consideration (3%) - $6,750
Rent Credits ($300 x 24) - $7,200
Final Purchase Price $211,050

All of these factors will typically make your rent payments higher than normal. Buyers typically sees them as down payments for the home they're purchasing, and the sellers see them as compensation for maintaining the property and taking it off the market.

Instances Where the Buyer or the Seller Would Get a Better Deal

Buyer
If everything goes well and the buyer is ready and able to purchase the home at the end of the term, they get a better deal, but ultimately it works out for both parties. The home won't sit vacant as it traditionally would, and this works for the seller.

  • Flexibility. A contract with a purchase option is more flexible than a standard mortgage. If a new job opportunity arises which requires moving or there are major family changes then one does not have to rush to sell a home or pay two sets of rent or mortgage at the same time.
  • Profit from Rent Payments. When the month is done rent payments disappear for typical renters, whereas RTO buyers have a portion of their rent payment apply to the property.
  • Save for Downpayment. The buyer will have time to save up for a decently sized downpayment, which can help them obtain a better mortgage rate.
  • Build Credit. The buyer has also had time to build credit and get out of existing debt.
  • Property Appreciation. If the property increases in value during the contract the buyer gains access to that appreciation.
  • Privacy. While renting the buyer is not listed on the deed in public county records.
  • Inspect the Property. The buyer gets to live in the home before they buy it, and this gives them time to find any potential problems.

Seller
If the buyer defaults on the agreement, the seller gets a much better deal.

  • Steady Revenue Stream. The seller is collecting money the entire time the tenant is living there and paying rent for the RTO contract, and they normally wouldn't have made anything if the property would have sat vacant.
  • Escalating Revenues. Contracts state the rate rent increases each year so the seller will be able to depend on improving revenues as the contract ages.
  • Long-term Income Stability. The longer a buyer rents an RTO the more incentive they have to keep paying to get value out of any equity they built up. They have a greater desire to keep paying the longer they live there due to their sunk cost.
  • Tax Benefits. Long-term capital gains are taxed at a lower rate than short-term capital gains. If a renter is in a property for multiple years before buying it then the seller gets taxed at a lower rate than if they quickly flipped a home.
  • Grow Equity. While the renter is paying the owner's equity in the property increases until it is purchased outright.
  • Lock in a Purchase Price. Contracts often allow for escalating prices & the ongoing rental payments help increase the effective purchase price through equity growth during the loan.
  • Potential Bonus Income. The seller gets to keep the option fee, even if the buyer defaults. However, if the buyer defaults, the seller has to have enough liquidity to manage the property payments while the property was fixed up, advertised, and rented to the next tenant.

Rent to Own, Purchasing, and Renting Price Considerations

The costs of RTO, straight renting, or purchasing a home depends largely on several factors. You should carefully consider all of them before you make your final decision, as you could end up accidentally locking yourself into a contract that costs you thousands more than other options. If you're not sure if renting, RTO, or purchasing a property is right for you, use this tool to check the costs.

  • Affordability. Renting and RTO are typically cheaper than purchasing a property outright, at least initially. If you simply can't afford a down payment and all of the miscellaneous fees, renting or RTO may give you a chance to put money away for a down payment. Those two options usually have fewer upfront costs. However, if you choose to rent, you won't have much to show for it after years like you would with RTO or purchasing a property.
  • Availibility.One of the biggest factors when it comes to your choice of purchasing a home, renting, or RTO, is availability. Chances are, there will be homes for rent or to buy in the area you want to live in. However, RTO options may be more scarce and difficult to find. If you're on a time limit, this isn't a good thing.
  • Credit. Your credit plays a large role when you apply for a mortgage. If you have poor credit, or if you have a thin credit history, renting or RTO may be a better option because they will both give you a chance to build your credit. This will give you time to get out of any debt you may have and establish a good repayment history. If you have excellent credit and you can afford a down payment, outright purchasing a home would most likely be a better option.
  • Location. Your location will play a vital role in whether you choose to rent, buy, or rent to own your next home. In some areas, you may see rent prices that are double and triple the typical rate in the area because of demand. So purchasing a home or finding an RTO option may be a smarter option. It all depends on what you're willing to pay, and what you can afford.
  • Flexibility. It is far cheaper and easier to move from a rental than it is to sell a home. The person who owns a home they are selling may be stuck paying rent on their new property & mortgage payments on their old property at the same time. Realtors also get a substantial commission when they sell properties.
  • Liquidity. The housing market has historically underperformed stock market returns. Those who compoud their savings in the stock market have much higher liquidity as they can exit their positions almost instantly. Selling a home can take many months & perhaps longer if the local market is a buyer's market.
  • Price. Asset prices have become inflated by nearly a decade of intervention by central banks since the housing crisis. In many big cities you'll pay a price premium to own your home. The cost of ownership is not just the monthly loan payment, but also includes things like: maintenance, property taxes, homeowner's insurance & the opportunity cost of not investing the equivalent sum of money into higher yielding & more liquid investments. When all these other costs are considered, NerdWallet found that in 2015 the ownership premiums can range from 33% to 93% more per month than it would cost to rent. That said, the NerdWallet data has a skew to it, as some people may buy large opulent homes whereas the common rental dwelling is far more subdued. What matters more than any overall trend is running the numbers on your options. In many neighborhoods rent costs about double what the associated mortgage payment would be for the same exact property, though it is worth noting the property owner also has to pay for maintenance and other costs of ownership.
  • Stability. A lot of people benefit from a sense of stability from owning. Is it worth it to you to pay more to own your home? Is this a spot you plan to live for a long time?
  • Market Timing. One of the biggest investment flaws people have is projecting the recent past trends indefinitely into the future. This is part of why people crowd into markets near the top & sell out of fear near the bottom. Institutional investors tend to be more pragmatic & experienced at investing than most individuals are. Those who have liquid cash during recessions are able to flip the cost structure by buying homes at rock bottom prices. This is why hedge funds bought large portions of the residential housing supply in Phoenix and other cities after prices sometimes fell by more than 50%. Blackstone acquired 40,000 homes and created derivative products based on the rental payments.

Homes and Strategies That are Available to RTO

Typically RTO availability is higher when the local housing market is weak and property owners feel the need to be more flexible to keep positive cashflow.

Traditionally, there are two different types of RTO options. Each strategy has its advantages and disadvantages, as well as reasons why sellers opt to do RTO for their properties. As long as a seller owns the home outright, they can choose to use the RTO strategy to sell the property. This includes condominiums, townhouses, single-family homes, and multi-family homes.

Property First RTO

This method starts with a seller who owns a property, and the goal is to find a tenant who is willing to rent-to-own the property. The property owner markets the home as an RTO, sets up showings, takes applications, and filters out the applicants. It allows the prospective tenant to move in right away.

Tenant First RTO

The second method starts with a tenant who wants to RTO a property and wants to buy it out at the end of the contract's term. An investor will then match the tenant to a property that works with their budget. When they locate a property, they can collaborate to close the deal, and the tenant can purchase the property on an RTO basis. This method works out well for real estate investors as they don't own the home, they're just acting as brokers to find the tenant their RTO property.

Why Sellers Choose to Use Rent-to-Own to Sell Their Properties

There are several reasons why a seller may choose to use this option when they want to sell their property. It has been gaining popularity for years, and investors are trying to exit their positions while locking in gains from buying homes near the bottom after the recession.

Bigger Applicant Pool

When you rent-to-own, you can target both buyers and renters as potential candidates to RTO the property. A buyer could purchase the property on an RTO basis, and either live in it or turn it into an investment property once the contract ends. A renter may want to purchase a property but doesn't have the means to do so right now. Any RTO property could be a big draw for them because it gives them time to save before purchasing the property. The seller has an increased chance of RTO their property.

Chance at Better Tenants

Renters can be very hard on rental homes if they don't have a vested interest in them. However, with RTO, they have a vested interest because they will be purchasing this home at the end of the contract. This will usually urge them to take better care of the property while they're living in it.

Consistant Cash Flow

If you don't use this method and your home sits vacant for however long it takes to sell; you're not making money. If you have a tenant in your home for this period, you'll be getting a steady cash flow each month in the form of rent. You won't have to worry about hurrying to sell your home to recoup some of your money.

Higher Rent

Traditionally, if you opt to rent a home on a rent-to-own basis, the seller is able to charge higher rent amounts. This is because the rent amounts go toward a down payment on the home and to cover the seller's mortgage payment. They can also charge a higher rent because they have more flexible payment terms.

Sell for a Higher Price

The real estate market is almost impossible to predict one month from the next, let along one year from the next. If you enter a contract with a tenant for RTO, you can lock in a selling price for the duration of your contract. This means that no matter what the real estate market does when it's time for the contract to end, you may end up getting more for your home than it's worth in the current market.

Tax Benefits

If a seller chooses to sell their homes outright, they immediately lose out on any tax benefits. However, with renting-to-own, the seller gets to enjoy the tax benefits that come with owning their home for a few more years until the contract ends and the tenant buys the property.

Property Needs Repairs

Many low-cost properties have major issues. Unscrupulous parties may try to sign tenants who unwittingly agree to pay out of pocket to repair major issues with a property they do not yet own.

Scammy Contract.

Individuals Who Should Consider Rent-to-Own

There are several individuals that the rent-to-own option would be a good fit for. It can be a way to help you polish your credit or add depth to a thin credit file.

Difficulty Obtaining Financing

The more times a person tries to obtain a mortgage and gets turned down, the harder an impact this will have on their credit. It could even lower their credit score. If a lender pulls their credit report and sees multiple failed attempts in a short amount of time, they'll be less likely to work with them. A rent-to-own contract usually doesn't require a credit check, and the tenant can give their credit score time to recover.

Low or Poor Credit

Traditionally, the lower your credit score is, the more likely you are to either get denied for a mortgage or get charged higher interest rates. You want to get the best rates possible because this will reduce the amount you pay back in interest over the life of your mortgage. An RTO contract can help you strengthen your credit by giving you a history of on-time payments. It can also add diversity to your credit history, which can improve your score over time.

High Debt-to-Income Ratio

Your debt-to-income ratio can have a negative impact on your credit history and stop you from obtaining a mortgage if it is on the high end. By entering an RTO contract, the individual with a high debt-to-income ratio won't be adding on more debt right away. They usually have two or three years to straighten out their finances and lower their debt-to-income ratio, so they qualify for a mortgage.

Short on Money

Many people who want to purchase their own homes might not have the money on hand for a 20% down payment or money to cover the miscellaneous fees that come with buying a home. An RTO contract gives them a period to save up for a downpayment, and a portion of their rent money will also go toward their down payment or earnest money once the contract is up. This can act as a cushion, and they won't have to worry about paying such a high down payment amount.

Common Misconceptions About Renting-to-Own

Woman With Confused Look on Her Face.

There are several misconceptions about the RTO process, and they have the potential to stop buyers from considering this option when it comes time to purchase a property.

  • It's Flexible. While you will have more flexibility initially with this type of contract than with a traditional mortgage, once the contract is signed, it's pretty set. It is very rare that both the buyer and the seller agree on alterations to the original contract. The price of the property is usually set, and this is the price that the buyer will have to pay once the contract is up, regardless of the home's current market value.
  • RTO and Renting are the Same Thing. When you rent a property, you rent goes to the landlord, and you won't see it again. With RTO, part of your rental payments goes into an escrow account. You will get this back when the contract term ends if you purchase the property. It can act as a down payment for the buyer, and collateral for the seller.
  • You're Eligible With no Money and Bad Credit. It is easier, in general, to get approved for an RTO contract. However, each seller is different, and they will all have different guidelines and stipulations any possible tenants must meet. They could ask for a minimum credit score, stable payment history, a smaller percentage down, and proof that the tenant can obtain financing at the end of the contract.
  • It's not Legally Binding. Contrary to popular belief, you are signing a contract when you enter an RTO agreement. While you can choose to back out of the agreement once the contract is up, you'll forfeit any money that you've paid in so far. If you choose to back out early, you could be in danger of legal ramifications from the seller.

Places to Find Rent-to-Own Homes

When you decide that rent-to-own is the right choice for you, you'll have to start looking for places that list RTO homes for sale. It might seem like a difficult thing to find at first, but several websites list them. One thing to note about these types of sites is some of them charge a fee to view information. Be sure to use a credit card rather than a debit card so you can more easliy dispute charges if you keep getting charged after you stopped using the service and contacted the company to cancel any ongoing subscriptions. It is hard to point out gotchas to specific websites while publishing an article like this because businesses can be bought & sold, and new owners may be more aggressive with monetizing customers than the old owner was.

Get Rent to Own.com

The first website on our list is getrenttoown.com. With this site, you simply put in your desired zip code and click search. It'll show you houses that are for sale because of foreclosure, owner financed, pre-foreclosures, auctions, for sale by owner, and RTO. Once you sign up for the site, you'll get access to contact information, information about the listing, area demographics, and a property summary. The site also has an RTO buyer's guide, overviews, and resources.

Home Star Search

At homestarsearch.com, you start by typing in the zip code of the area you want to search RTO listings in. It'll pull up any RTO homes within a certain mile radius of your desired zip code, and you can click on each one to get more details. Once you've registered for the site, you'll get in-depth information about each property including pricing, the number of bedrooms or bathrooms, and how big the property is. There is also seller contact details so you can talk to them directly.

Housing List

If you want to see different types of homes for sale in your area including RTO listings, housinglist.com is a great resource. When you pull up the site, it'll ask you for your desired zip code. When you enter this information, a list of different houses will come up along with how they're being sold. There are foreclosures, for sale by owner, real estate listings, and RTOs. You click on 'get more details' to see more about the houses. You register for the site to get access to contact information and additional house information.

iRentToOwn.com

The iRentToOwn.com site operates like the ones listed above. You enter your zip code, and it'll put up different houses in the area. You can filter your results by bedrooms, and the listings show who owns the home before you click on them. It also tells you what types of credit are accepted. After you've found a listing and clicked on it, and for more information you register for the site. You can opt-in for alerts for properties that interest you, and contact the sellers for more information.

JustRentToOwn

The justrenttoown.com site also lets you search by zip code for eligible homes. As soon as you've input your zip code and searched, you'll get a list of homes. You can click for details, but you have to register to see an in-depth offering of each listing. When you register, you will get access to seller contact information as well. There is a rent-to-own guide for potential applicants as well.

Zillow

Zillow.com allows potential tenants to search by zip code for houses. Once you've searched, you'll be able to filter the home results by type from RTO and foreclosures to auctions and broker-owned. You'll have to create an account to get seller information, but there are email forms you can fill out to contact a broker directly to ask about the property. Be warned that Zillow has a history of cross-selling user information to third party brokers rather that choosing to connect interested parties with the real property broker. The button to contact the correct broker may be grayed out and their contact information may be hidden below the fold after many screens of other information.

Pros and Cons of Renting Versus Owning a Home

When it comes to renting your home or owning your home, there are pros and cons for each option. It all depends on what you want in the big picture for yourself and your family.

  • Flexibility versus Stability. When you own your own home, you get a sense of stability. It's your home, and you're going to stay there for the foreseeable future. However, this can be confining to people who like to move around. Renting offers you the ability to pick up and move on short notice, and you don't get this with owning a home.
  • Maintenance. When you own your home, all of the maintenance costs fall to you as the homeowner. If something breaks, you're responsible for fixing it. If you rent, you generally won't be responsible for repair or maintenance costs. This is your landlord's responsibility, and part of the reason you pay rent each month.
  • Predictability. When you rent, you know exactly what you're going to pay each month, and this can help you budget and build your savings or pay off debt. Anyone who owns their own home has a general idea of what they'll pay each month, but if an emergency comes up, they'll have to have money for that. This can make it harder to save.
  • Income Tax Benefits. As a homeowner, you can enjoy the ability to deduct mortgage interest paymets from your income when calculating income taxes. However, these deductions only make sense if they are above the standard deduction levels, as those who do not have mortgage debts are entitled to take the standard deduction. Most people purchasing a home through a (relatively) high-interest rent to own loan likely have a limited amount of debt associated with the purchase, which is unlikely to exceed their standard deduction. Given how low interest rates are on traditional mortgages, if the homebuyer had a high income and could qualify for a large loan they would probably use a traditional mortgage rather than a less certain rent-to-own option.

In countries like Germany most people rent rather than buying. Rental rates have been rising across the United States since the financial crisis as wages have failed to keep up with inflation & QE drove asset prices higher.

United States Household Composition

Type of Household Households % of Total Residents % of Total
Renter-Occupied 43,837,496 37% 111,054,354 35%
Owner-Occupied 75,022,569 63% 203,993,282 65%
Total 118,860,065 100% 315,047,636 100%

Source: 2016 American Community Survey, 1-Year Estimates, US Census Bureau. Updated 9/2017

Pros and Cons of RTO

Renting-to-own your next property also comes with several pros and cons. The payoffs can be worth going through the process, but there are large drawbacks to consider as well.

  • Forfeit Money. If you break your rent-to-own contract, you forfeit all of the money you've paid in so far. This includes your rent, rent credits, and the option consideration. This can quickly add up to a decent amount of money that the seller will get to walk away with.
  • Home Could Lose Value. At the beginning of the RTO contract, a home price is usually locked in. While this is normally a good thing for the seller, the buyer could end up paying more for the home than they would have originally paid because the market can fluctuate.
  • Save Money. RTO allows potential buyers to save money while they're renting the property. Since the rent is usually set, they know exactly what they're going to pay each month. Also, part of the rent gets saved for a downpayment automatically.
  • Test the Home. Once you've signed an RTO contract, you'll get to test the home for a period while you're under contract. This gives the tenant an excellent opportunity to live in the home and see if it meets all of the qualifications they'll need.

Different Contracts

The option of renting-to-own a property comes with many different contract types that the buyer and seller can choose to utilize. Each of these contracts is slightly different in what they offer for the buyer and the seller.

Lease Purchase

This option, also referred to as a land installment contract or contract for deed is the most popular contract for RTO agreements. A lease purchase contract uses traditional rental contracts, and it locks the tenant into purchasing the house once the contract is up. It should include rent amounts and due dates, rent credit amounts, property price, terms and rules, and duration of the contract. You will also have to decide who takes care of maintenance and repairs while the RTO contract is binding, and what portion of the rent payment goes to the down payment amount as a rent credit. This type of contract makes it mandatory for the tenant to purchase the home once the contract is up. If they choose not to, or if they're unable to, they can face legal issues.

Lease Option

A lease option is a contract between the potential tenant and the seller that specifies the agreement to rent the property for a set amount of time and it comes with a right to refuse option that gives the potential buyer a way out at the end of the contract's termination date. It should include how much the rent is, when it is due, fees, penalties, security deposit amounts, pets, smoking requirements, parking, maintenance responsibilities, and utilities. The main difference between a traditional lease and a rent-to-own lease is deciding who will pay for upkeep and maintenance. In a traditional lease, a landlord would take care of all of these things. With RTO, the tenant might be responsible. It should also clearly specify that any rent credits or any amount of money that the tenant has had set in escrow becomes forfeit if they choose not to purchase the home. This releases them from their obligation to purchase the property, and the seller is responsible for finding a new tenant.

A large portion of lease option contracts simply end up as an expensive way to rent, because the renter pays more for the rent while living in the home to lock in the option & whatever caused them to not be able to qualify for a traditional mortgage often still holds them back from being able to qualify for one at the end of the mortgage.

Contract Set Up

For maximum personal protection it is best for renters to keep the lease & purchase options as 2 separate contracts if possible. This protects the tenant from being liable to pay for unknown & expensive property maintenance while also making it clear what the costs are for each aspect of the agreements. A leaky roof seen during the first rain is easy enough to spot, but it might not be easy to know there is a problem with a septic tank until you lived in the house for a while.

House With a Broken, Caved-in Roof.

Wrap-around Mortgage

In this option the seller takes the buyer's monthly payment and applies it toward the mortgage, with a premium over the mortgage payment the seller can pocket.

Some lenders forbid this practice in their loan agreements. And there is also the risk that the property owner may keep the monthly payments without applying them toward the mortgage payment, leading to foreclosures.

Provisions

Whichever contract you choose to use for your RTO agreement, there are provisions that each should contain to protect both the buyer and the seller. The clearer everything is the more reduced the chances are of having a misunderstanding later.

  • Contract Time Frame. You'll have to set a term for the RTO process clearly. This is usually between one and three years. At the end of the contract's term, the tenant has the option to purchase the property or move on.
  • Option Fee. The option fee isn't negotiable, as this is the fee that you'll pay the seller for entering an RTO contract. You can negotiate a monetary option fee, a material option fee, or repairs to the home.
  • Purchase Price. You can either set the purchase price when the contract is originally made or at the time of closing the contract. This typically won't make a huge difference to the buyer, but it'll make a difference to the seller as the real estate market can fluctuate.
  • Rent Credit. Your contract should clearly outline how much is coming out of each rent payment for a rent credit. This is typically between $200 and $350. This is the money that will go toward your down payment amount in escrow.
  • Repairs. Repairs and maintenance responsibility should also be clearly outlined. Usually, the seller will take care of them until the tenant officially purchases the house. However, they can ask the tenant to cover them, and with an RTO contract, they usually do. Have the home inspected to be sure no major repairs are needed before signing to agree to be responsible for them.
  • Voiding the Contract. It is critical to include what conditions or terms would make the rent-to-own contract void. Things like owning a pet if it was agreed that the tenant wouldn't own one, criminal activity, or if the tenant is unable to obtain financing at the end of the contract's term.
  • Financing. Some owners will provide owner financing, however these terms must be agreed to upfront. It is common for owners to want to get at least an 8% rate of interest, whereas traditional mortgages may be available at lower rates to those who qualify. Some seller-financed sales are "toxic transactions."

RTO Pitfalls

Although the RTO option seems good on paper, there are several potential pitfalls that both buyers and sellers should be wary of. They could end up costing them thousands if they're not careful.

Limited Availibility

Even though RTO is catching on and gaining popularity, they are still limited in comparison to regular buying methods. You may have difficulty finding rent-to-own options in the area that you want to purchase a home.

Price

You will usually pay higher prices with a rent-to-own arrangement. These inflated prices are due to your rent money going for two different things, as well as miscellaneous fees that the tenant will be responsible for. You could also start out paying a slightly lower price and have it go up each year. Some clever buyers have paid inflated rents for a short period of time before coming into a "sudden windfall" to buy the property early, though contracts are typically created by the seller with the seller's interests first.

The Seller Could Lose the House

As a tenant with an RTO contract, you have to keep in mind that the seller could lose the house during the rental period. This could happen due to foreclosure, divorce, or an inability to keep up with payments. If this happens, the tenant loses out on purchasing the house and will most likely forfeit any money they paid in.

Scams

Scammy Deal.

Unfortunately, there are a lot of RTO scams that any potential buyers have to watch out for. If something sounds too good to be true, it usually is. If you don't' trust the seller, or if they're asking for a lot of money upfront, leave it. There are legitimate RTO options available. You don't have to take the first one that comes along. Ensure you read the fine print and have a Realtor and/or a real estate lawyer verify the contract is fair. Many deals are fair - particularly those offered by local nonprofits like SHOP - but dishonest companies who do not disclose major issues can destroy people's lives:

"rent-to-own agreements reside in a gray area of the law. An examination by The New York Times of contracts and court filings, as well as interviews with housing lawyers and more than a dozen of Vision’s customers across the country, found that these deals are risky, lack consumer protections and may not be enforceable in some states. Most tenants walk away with nothing, having sunk money for rent and repairs into homes they had once hoped to own. Others faced surprise evictions, having signed a contract that did not disclose what repairs were needed, yet set a deadline for making sure the home was up to local housing code. As different tenants move in and out of the same property over the course of years, many homes fall further into disrepair."

If you have any concerns please contact the HUD Housing Counseling and Referral Line at 1-800-569-4287 before signing any contract, or if you already signed a bad contract, as soon as you run into a major issue.

Consequenses of Deciding Not to Buy or Missing Payments

These consequences should be clearly outlined in the rent-to-own contract. If a tenant misses payments, the seller can choose to start the eviction process, and the buyer will forfeit any payments that they have made so far, including the money that is in escrow. Depending on which type of contract you're locked into, there may be legal consequences. If you've chosen a lease option, you have the choice to opt out of buying the home without any lasting consequences. However, if you've chosen the lease purchase, you are required to buy the home at the end of the contract. If you don't, the seller could start legal proceedings for breach of contract.