Many renters dream of one day owning their own home, but may find it challenging to secure a mortgage or save for a down payment. In such cases, a rent-to-own agreement can help you on your path to homeownership.

A rent-to-own agreement allows you to enjoy many benefits of renting while preparing to eventually purchase the current residence you’re living in. This article will explain how rent-to-own works.

What is a Rent-to-Own Agreement?

Rent-to-own plans are designed to offer tenants a chance to accumulate a down payment for the house they’re renting and provide homeowners a way to earn extra income from renting out their property.

Rent-to-own plans start with an agreement between the landlord and the tenant. Before any agreement is reached, both parties must sit down to negotiate several key components of the rent-to-own agreement:

• Option Fees
• Lease Term
• Monthly Rent
• Rent Premium
• The Final Sale Price of the Home

Option Fee

The option fee is a fixed amount paid by the tenant to the landlord at the time of signing the agreement. This fee ensures the tenant has the right to purchase the house at the end of the lease period.

If the tenant decides to buy the house, the option fee will be part of the down payment. If the tenant decides not to buy the house, the landlord keeps this fee.

Lease Term

The lease term is the duration the tenant will live in the house. The tenant pays rent and a rent premium every month during their tenancy. At the end of the lease term, the tenant either purchases the home, renews the lease, or moves out.

Monthly Rent

The monthly rent is the amount the tenant must pay each month. This is no different from the rent on any lease agreement.

Rent Premium

The rent premium is an additional fee that must be paid every month. Like the option fee, if the tenant decides to buy the house, this amount will be part of the down payment. If the tenant decides not to buy the house, the landlord keeps the rent premium.

Final Sale Price

The final sale price of the house is agreed upon at the time of signing the rent-to-own agreement. The sale price does not change even if the house prices in the neighborhood go up or down.

Ensure other aspects clearly stipulated in the contract are who is responsible for maintenance and who pays taxes or HOA fees.

I Own a House. Why Should I Put It on the Market as Rent-to-Own?

If you own a house and want to make some money from it, then rent-to-own has many benefits.

The biggest benefit is that renting out can bring in more income than regular renting. The rent premium paid by tenants every month will make your income higher than market price. This could be the difference between a real estate that generates positive cash flow and one that doesn’t.

After signing a rent-to-own agreement, you’ll also encounter fewer tenant issues. If tenants are considering buying the house, they will want to help keep the house in the best condition.

Although it’s not certain whether the tenant will eventually purchase the property, a rent-to-own agreement lets you lock in the sale price of the house. If the property value decreases, as long as the tenant decides to buy, you get to know the sale price of the house before actually selling it.

Of course, this could also work against you. If property prices go up, your tenant could buy your house at a discount because the price was set at the start of the contract.

Another major downside of rent-to-own is that you must give the tenant the first right to purchase the house. If someone else wants to buy the house, you can’t sell it to them. A rent-to-own agreement means you have to wait until the lease ends and the tenant decides not to buy the house.

I’m Looking for a Place to Live. Why Should I Consider Rent-to-Own?

For those with poor credit or difficulty paying a down payment, rent-to-own real estate is a good way to make the path to homeownership possible.

The rent-to-own lease can last a year or more. For buyers with poor credit or those needing time to accumulate income, this period might be just what they need to qualify for a mortgage. You can start building equity through option payments and rent premiums and continue building equity after purchasing the house.

You also get a preview of your future house, which most homebuyers can’t do. If you find major issues with the house, you can back out of buying but will only lose the rent and option fee.

The loss of the rent premium and option fee is the biggest disadvantage for renters. If you can’t qualify for a mortgage, or for other reasons can’t buy the house, then you’ll lose the extra money you put into the agreement. You’d get to keep this money if you had signed a normal lease.

Another issue is that you still need to pay an option fee to secure the rent-to-own agreement. While the option fee isn’t as high as a down payment, it still amounts to 3%-7% of the home’s total value.