7 Must-Have Terms in a Rent to Own Agreement

Rent-to-own agreements seem like a great idea, but how exactly do these deals come together and what do those contracts involve? Understand how these unconventional arrangements work and if they are the right fit for you.

By
Nichole Stohler
|
Last Updated
January 5, 2024
7 Must-Have Terms in a Rent to Own Agreement

Are you a tenant longing for homeownership but don't have money for a sizable down payment? Or are you a property owner who wants rental income without all the headaches of hands-on involvement?

Rent-to-own agreements could offer a solid fit for both would-be homeowners struggling with financing as well as landlords wanting to lower day-to-day management burdens.

This guide explains exactly how rent-to-own work agreements function. We'll summarize major upsides and downsides for tenants and landlords to weigh and break down what both property owners and aspiring owners need to know before signing a contract.

Whether you're a tenant trying to buy a home despite various obstacles or you're a landlord looking to acquire effortless rental income, read on to see if rent-to-own could be a fit for you.

What is a rent-to-own agreement?

A rent-to-own agreement can benefit both landlords and aspiring homeowners. It allows tenants a chance to rent a property first with an option to buy it at an agreed upon price when the lease ends.

Landlords maintain ownership during the lease option contract while earning rental income. While the tenant rents the property, part of their payments go into an escrow account for their later down payment if they purchase the home, incentivizing them to upkeep the property.

If the tenant ultimately doesn't complete the sale, the landlord regains full control to find new renters or sell to another buyer. The tenant also handles most maintenance duties, so there's less day-to-day management burden on the landlord's end.

What's in rent-to-own agreements?

Unlike typical rentals, rent-to-own agreements are unique contracts with their own set of terms and standards. While exact details can shift around, most rent-to-own agreements include these core pieces: 

Lease term

The lease term in a rent-to-own agreement establishes the duration of the lease period before the tenant can purchase the property.

This time frame usually spans one to three years, providing the tenant time to evaluate the rental property and decide if they want to buy it.

Purchase option

Rent-to-own agreements include a purchase option that gives the tenant the sole right to buy the property at a pre-set price within a specific timeframe.

This locks in the opportunity to purchase the home, even if market values increase during the rental period. Tenants can take time evaluating if homeownership makes sense knowing that they alone control the option to buy the property if they decide they're ready. The purchase option provides certainty amidst an unpredictable market.

Rent payments

The rent payment structure is an important component of a rent to own house contract. The tenant pays a monthly rent amount, which may be slightly higher than the market rate. The reason is that the landlord may credit a portion of this payment towards your eventual purchase of the property.

The extra amount of monthly rent builds up savings for the tenant. As the extra rent money grows over the lease term, it can be applied to the down payment when the tenant is ready to exercise the purchase option.

Purchase price

If the tenant decides to exercise their purchase option, they can buy the property at the agreed-upon price. The purchase price may be established at the beginning of the agreement, while in other instances, it may be determined based on an appraisal conducted closer to the end of the lease term.

Both parties should establish and document the purchase price to avoid ambiguity or disputes during renting and owning.

Option fee

An option fee is a non-refundable upfront payment that the landlord may require from the tenant at the beginning of the rent-to-own agreement. This fee is separate from the monthly rent payments and compensates the landlord for granting the tenant the exclusive option to purchase the rental property.

In some cases, the landlord applies the option fee to the purchase price, which reduces the total amount rent-to-own tenants need to bring to closing.

Maintenance and repairs

The responsibility for maintenance and repairs is different in a rent-to-own agreement than in a traditional lease. Just like a traditional homeowner, the tenant assumes these responsibilities, since they will eventually purchase the rental property.

Both parties should understand and outline the agreement's expectations regarding maintenance and repairs to avoid any misunderstandings or disputes during the lease term.

Default and termination

Rent-to-own home agreements should include provisions that explain the consequences of defaulting on payments or breaching the contract terms. These provisions help protect both parties' interests and make sure that there is a clear understanding of the actions and remedies available in case of default.

The agreement should also specify the circumstances under which the tenant or the landlord can terminate the agreement and outline the procedures to follow in such situations.

Types of rent-to-own contracts

A rent-to-own contract comes in two main kinds, each with its own spin to suit different buyers.

  • Lease-option agreements: The lease-option agreement gives tenants the choice to buy the property or walk away when the lease ends. The sale price is usually set early on or tied to an appraisal down the road. Tenants can weigh whether stepping into ownership makes sense as that deadline nears.
  • Lease-purchase agreements: Lease-purchase agreements mean tenants must finalize the sale at the end of the lease. The purchase price is typically locked in upfront. This route provides more certainty for landlords banking on the tenant as a buyer.

Pros and cons of rent-to-own

Rent-to-own homes are appealing to both tenants and landlords, as tenants work toward home ownership while landlords collect income with a ready buyer at the end of the lease period. But, what are the potential downsides? Let's look at the key pros and cons for both landlords and tenants.

Pros for tenants

  1. Path to homeownership: A rent to own housing contract provides a pathway to homeownership for individuals who may not be ready or able to purchase a home outright. This allows tenants to live in their desired property while gradually building equity through monthly rent payments.
  2. Flexibility: Rent-to-own agreements offer flexibility for tenants. They can choose whether to proceed with the purchase at the end of the lease period, giving them time to assess the property, neighborhood, and their own financial circumstances before committing to homeownership.
  3. Potential credit improvement: Rent-to-own agreements can improve tenants' credit scores. Tenants can demonstrate financial responsibility, potentially improving their creditworthiness and increasing their chances of obtaining favorable financing terms when purchasing the property by making timely rent payments.
  4. Price lock: Rent-to-own agreements often include a predetermined purchase price or a price based on an appraisal. Using current market value protects you against potential increases in property values and allows you to benefit from any appreciation during the lease period.

Pros for landlords

  1. Consistent rental income: In a rent-to-own deal, landlords receive steady rental payments from qualified tenants who are properly maintaining the property while considering purchasing it.
  2. Motivated buyer: You have a motivated potential buyer if the tenant decides to move forward with the home purchase option down the road.
  3. Risk protection: A locked-in sales price provides downside protection for landlords if the market changes and property values decline.

Cons for tenants

  1. Higher monthly costs: A lease purchase agreement often requires tenants to pay slightly higher monthly rent amounts. Tenants should carefully consider whether the increased costs fit within their budget, but the future purchase of the property may credit some of these payments.
  2. Potential loss of invested funds: If you decide not to proceed with the purchase at the end of the lease period, you may lose the additional payments made towards the purchase. Be sure to understand the agreement's terms and conditions for refunding or crediting these funds.
  3. Limited inventory and options: Rent-to-own properties may have a more limited inventory than traditional home purchases or rentals. It can limit the options available to tenants, potentially making it harder to find a property that meets their needs.
  4. Responsibility for maintenance and repairs: Tenants may be responsible for routine maintenance and necessary repairs during the lease period depending on the terms of the agreement. Be aware of these responsibilities upfront to avoid any surprises or unexpected costs.

Cons for landlords

  1. Lower earnings if no sale: If the tenant does not execute the purchase option, landlords lose out on potential earnings from an immediate sale to another buyer.
  2. Property condition risk: Tenants controlling maintenance during the lease term could negatively impact the future sale value if they don't maintain the rent-to-own home. Specifying all repair responsibilities in the lease purchase contract can help to reduce this risk.

Finding a rent-to-own property

If you're ready to search for a rent-to-own property, there are several steps you can take to increase your chances of finding the right option for you. Here are our top tips:

  • Research online listings: Start your search by looking for properties on reputable real estate websites or platforms. These platforms let you filter your search specifically for rent-to-own properties, making it easier for you to find options.
  • Network with real estate professionals: Connect with real estate agents or brokers who have experience with rent-to-own transactions. They may have access to exclusive listings or be able to connect you with landlords who offer rent to own contracts. They can also provide guidance and insights throughout the process.
  • Local property management companies: Reach out to local property management companies or landlords with properties available for rent-to-own. These companies often have a variety of properties under their management and might know of landlords open to rent-to-own arrangements.
  • Drive through target neighborhoods: Drive through neighborhoods where you'd like to live, and look for "For Rent" signs. Some homeowners may be open to rent-to-own agreements but may not actively advertise them online — seeing a sign could present an opportunity to ask if the seller is open to it.
  • Use social media and community forums: Join online community groups or forums dedicated to real estate in your area. These platforms can be a great resource for discovering potential rent-to-own properties. People often post listings or discuss opportunities in these groups, enabling you to connect with interested landlords.
  • Collaborate with local nonprofits or housing organizations: Some nonprofits and housing organizations specialize in assisting individuals or families with affordable housing options, including rent-to-own agreements. Contact these organizations to ask about available properties or programs that may suit you.

Things to do before signing as a rent-to-own tenant

Eager to sign that rent-to-own paperwork and snag the keys? As eager as you may be, doing your due diligence beforehand pays off. Don’t just skim the fine print or take the terms at face value.

Here are some key areas you should explore and understand before signing as a rent-to-own tenant:

1. Conduct home research

View and inspect the property you're considering for rent-to-own. Look at its condition, amenities, location, and any possible issues that might affect your decision to proceed with the purchase. Consider hiring an inspector to identify any hidden problems that could impact the fair market value or livability of the property.

2. Conduct seller research

Research the seller or landlord to verify their reputation and track record. Look for testimonials from previous tenants or buyers who have engaged in similar types of lease purchase agreements with them. It helps to understand their reliability, trustworthiness and make sure you aren't a victim of a rent-to-own scam.

3. Select the right terms

Make sure the terms of the rent-to-own agreement align with your financial capabilities and goals. Look at the purchase price, the amount of rent credit applied for the purchase, and any potential adjustments to the purchase price based on property appraisals. Choose terms that are realistic and workable for your circumstances.

4. Seek assistance

Consider getting assistance from professionals who specialize in rent-to-own transactions. Real estate agents, attorneys, or financial advisors can provide guidance and assistance throughout the process. They can help review the agreement, negotiate terms, and make sure that your interests are protected.

Buying rent-to-own homes

Here's a step-by-step guide on how to successfully buy a rent-to-own home:

  1. Negotiate the purchase price: One of the initial steps in the rent-to-own process is negotiating the home's purchase price before signing the lease agreement. Take the opportunity to discuss and agree upon the property's purchase price with the landlord or seller.
  2. Review and sign the agreement: Before finalizing the deal, review the terms and conditions outlined in the lease option or lease purchase agreement. Pay close attention to details such as the duration of the lease agreement period, the amount of the option fee, the rent, and any responsibilities regarding repairs and maintenance.
  3. Submit the option fee payment: Once you have agreed and are satisfied with the terms, you'll submit the option fee payment. This fee is typically a percentage of the home's purchase price. This fee is what allows you to guarantee your right to purchase the property later.
  4. Make timely rent payments: After finalizing the agreement and paying the option fee, make your monthly rent payments on time. Note that your rent payment might be higher than the market rate, since a portion of the rent payment goes towards your future down payment.
  5. Prepare to apply for a mortgage: As the end of the rental period approaches, you'll have the option to apply for a mortgage to complete the purchase of the home. If you choose this route, you'll need to follow the traditional mortgage application process to secure financing. You can start preparing to qualify for a mortgage by reviewing your credit score, gathering the required documentation, and consulting with lenders to understand your financing options.

Rent-to-own contract

Rent-to-own agreements let hopeful home buyers rent a property first while they prepare for ownership responsibilities. These non-traditional arrangements allow you to occupy your dream home as you save up. Meanwhile, landlords secure consistent rental income with a motivated tenant maintaining the asset and a built-in future buyer.

By leveraging the tips in this guide, you can position yourself favorably for a win-win through a rent-to-own agreement. Weigh the pros and cons for your situation, do your due diligence and research your options thoroughly, and use all the resources available to you. With the newfound knowledge acquired in this guide, you can go off into the rent-to-own market feeling confident.

Rent to own agreement FAQs

Are rent-to-own agreements available for any type of property?

Rent-to-own agreements can apply to various types of properties, including single-family homes, condominiums, and townhouses. Availability depends on the specific circumstances and the willingness of the landlord or seller.

Can anyone enter into a rent-to-own agreement?

Yes, but landlords and sellers may have specific qualification criteria for tenants entering a rent-to-own arrangement, like having a stable income and a good rental history.

What happens if property values change during the rental period?

With a rent-to-own agreement, the purchase price is usually determined upfront and does not change based on market conditions when the rental agreement comes to a close.

If property values increase, tenants benefit from buying the property at a lower price than the market value at the time of purchase. If property values decrease, tenants can walk away without moving forward on the purchase.

Nichole Stohler

Nichole co-founded Gateway Private Equity Group, with a history of investments in single-family and multi-family properties, and now a specialization in hotel real estate investments. She is also the creator of NicsGuide.com, a blog dedicated to real estate investing.

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