Rent to own: how it works, with examples

Rent-to-own lets you move into a home as a renter, with the right to buy it later at a price you agree on now. It's often used by people who want a home but need a year or two to fix their credit or save a down payment. It can work well, but it costs more than renting, and you can lose money if you don't end up buying. Here's how it works, with real numbers.

The parts of a rent-to-own deal

• The lease: you rent the home for a set time, often 1 to 3 years.
• The option to buy: the right, but not the duty, to buy the home by the end of the lease at an agreed purchase price.
• The option fee: money you pay up front for that right, often 1–5% of the price. It usually counts toward the price if you buy, and you lose it if you don't.
• Rent credits: part of each month's rent that counts toward the price. Not every deal has them, and the rent is often a little higher than normal rent to pay for them.

Watch the wording. A lease-option means you may buy. A lease-purchase means you've agreed to buy, and walking away can mean being sued.

A worked example

A family rents a home for $1,900 a month with the option to buy it for $280,000 within 3 years. They pay a $7,500 option fee, and $200 of each month's rent is credited toward the price. A similar home rents for $1,750, and the home is worth about $270,000 today.

If home prices rise 3% a year, the home is worth about $295,036 at the end. The family buys it for $280,000 and already has $14,700 toward it, so they own about $29,736 of equity on day one.

What you still need to buy

At the end you need a mortgage for the rest. Say the lender wants 5% down ($14,000). The family's $14,700 of credits covers it, but they still need cash for closing costs, about $8,400 here.

One catch: lenders decide whether credits count toward a down payment. Many lenders count only the part of the rent above market rent, and want proof of every payment. Talk to a lender before you sign, not at the end.

What if you don't buy?

If you walk away, you usually lose the option fee and the rent credits: $14,700 in the example. Compared with renting a similar home, walking away cost $12,900 (the $7,500 fee plus the $5,400 of extra rent). That's the price of the option, so go in with a real plan to qualify.

When prices fall

The price is locked in, which helps when prices rise and hurts when they fall. Take a $300,000 home with the same price in the agreement, a $6,000 fee and $250 a month in credits for 3 years. If prices fall 3% a year, it's worth about $273,802 at the end. Even with $15,000 of credits, the family would owe about $11,198 more than the home is worth. A lender may also refuse to lend against a price above the appraisal. You can usually just walk away, but you'd lose the $15,000.

For the owner

An owner earns the option fee and often a higher rent, sells at a price agreed in advance, and usually has a tenant who cares for the home. In the first example the owner collects $75,900 over 3 years and, with a $1,350 mortgage, keeps $550 a month. If the family buys, the owner gets $265,300 at closing (the price less the credits already paid). If they walk away, the owner keeps the fee, the rent and the home, but has to find a new tenant or buyer. The owner gives up any rise in price above the agreed price.

Before you sign

• Put the price, fee, credits, deadline and repairs in a signed agreement.
• Get a title search, and record a memorandum of the option with the county.
• Get an inspection and an appraisal, as you would for any purchase.
• Make sure the owner is current on their mortgage and taxes.
• Keep proof of every rent payment and credit.

Try your own numbers in the rent-to-own calculator, and compare it with the other ways to buy without a regular loan in creative financing for beginners. This guide isn't legal or tax advice. Lease-option rules vary by state, so have a real estate attorney review the agreement.