Rent-to-own homes are properties where a renter signs an agreement giving them the option to buy the property at a later date. In the meantime, the renter leases the property. The length of time a tenant rents before having the option to buy a property varies by contract but is often two to four years.

A rent-to-own agreement is a contract between a renter and a landlord that defines when and how a renter can buy a property. There are usually two parts to these contracts: 

Lease agreements for rent-to-own homes differ from standard rental leases. For one thing, rents for rent-to-own homes are usually higher than an area’s market rate. The higher rent includes the monthly rent payment and an extra amount, called the rent premium. This extra amount counts toward the renter’s down payment for use at the end of their lease.

Lease agreements rent-to-own homes also vary from standard rentals by making renters responsible for some or all property maintenance. In a typical rental, landlords cover property repair costs, but in rent-to-own homes landlords may ask tenants to pay for repairs and maintenance.

There are two common option types in rent-to-own homes: 

A rent-to-own agreement lays out the price a renter will pay if they opt to buy the property at the end of their lease. Some agreements determine the selling price at the contract’s signing. In these cases, the price is usually higher than the property’s current market value because a home’s value typically increases over time.

For example, let’s imagine a home has a $200,000 market value when the owner and renter sign a rent-to-own agreement. Average home values in that market rise five percent each year. The rent-to-own agreement is for two years. So the landlord lists the purchase price of the property at $220,000 ($200,000 times five percent home price appreciation times two years).

Some rent-to-own agreements don’t state the selling price upfront. Instead, the landlord determines the property cost at the end of the lease by looking at the local market.

Rent-to-own agreements also determine whether part of the rent paid will apply to the property purchase price — the rent premium. For example, a renter pays $1,000 a month in rent for a 24-month contract. Their agreement states that 30 percent of their monthly rent payment serves as a rent premium, which counts toward buying the home. If they make all their monthly payments in full and on time, they’ll have $7,200 for use in purchasing the property. 

Upon signing the rent-to-own agreement, the home buyers will pay an option fee, which typically runs between 3 and 5 percent of the home’s purchase price. This fee guarantees the renter the option to buy the property and prevents the property owner from selling the house during the lease agreement. 

Keep in mind that most agreements don’t require returning the rent premium or the option money to the potential buyer if they opt not to purchase. If the renter does buy the property, the seller often credits the rent premium and option fee toward the purchase of the home.

Rent-to-own homes offer a number of pros for buyers. First, these properties open a path to homeownership, even when someone doesn’t have enough money for a traditional down payment, which can range from five to 30 percent. With a rent-to-own agreement, the smaller option fee and monthly rent premium contribute to the down payment.

Rent-to-own homes also don’t require a mortgage at the outset, which can be an attractive option for people with poor credit. Yes, they’ll likely need a mortgage if they want to buy the home when their lease ends — but the one- or two-year lease term gives them time to improve their credit score while still ensuring they can buy a home they love. In fact, rent-to-own homes can help improve their credit if they make regular, on-time rental payments. However, some landlords require preapproval as part of their rent-to-own agreement.

Some homeowners may require mortgage lender preapproval for potential rent-to-own buyers — meaning they’ll need to have good credit at the outset.

The rental agreement also give buyers predictability. Monthly rent for rent-to-own homes is often set, meaning it will not increase during the lease.

Monthly rent for rent-to-own homes is usually higher than standard rentals because the payments include rent and the rent premium, which counts toward the renter’s down payment. This arrangement helps people who can’t afford a down payment, but higher rent payments can be a barrier.

The option fee, or option consideration, can be another issue with rent-to-own homes. Renters pay the fee when they sign the contract, but it’s often nonrefundable. The renter will lose the money they paid for the option fee if they don’t buy the house.

Additionally, home sales prices can drop. If the rent-to-own agreement negotiated the home purchase price at the contract’s signing, the renter can end up overpaying because landlords usually base the cost on market rates and expected home value increases when the contract is signed. The market purchase price of the home might decrease during that period, but they’ll still be stuck paying the higher price.

Another con of rent-to-own homes is that they limit your ability to move. With standard rentals, you can move at the end of their rental period, which is usually one year. Rent-to-own homes often obligate the renters to remain in the property for two to four years — and then purchase it afterward. This lack of flexibility can be a problem if a renter needs to move.

Rent-to-own homes are protected from market depreciation because investors can set the sale price in a rent-to-own agreement, accounting for expected appreciation. For example, an investor expects a property’s value to be $300,000 at the end of a lease. So, they list the purchase price at $300,000 in the contract. In many cases, that’s what the renters will pay regardless of how the market performs.

The option fee can benefit real estate investors, too. If the renters decline the option at the end of their lease, the investor keeps the option fee.

Rent-to-own real estate can be a way to create bigger profit through creative financing. Investors can benefit from the increased rent of rent-to-own homes. Assuming they buy the property, the extra money goes toward the renter’s down payment. If they don’t buy the home at the end of the lease term, though, the investor keeps all the rent collected during the contract.

Longevity is another benefit of rent-to-own homes for real estate investors. Rent-to-own agreements tend to last for two to four years. This length of time keeps investors from having to repeatedly secure a tenant.

Also, tenants have a personal and financial interest in the property. So they may treat a house better than they would if it were a standard rental. And real estate investors can make renters pay for some or all maintenance on a rent-to-own home.

There’s another hidden win for smart investors: sandwich leases. What is a sandwich lease? That’s when you go under contract with a low-priced lease purchase agreement and then find rent-to-own buyers who would like to purchase the home. 

One of the cons of rent-to-own homes for real estate investors is that a property’s title may scare away banks. Investors cede ownership of a property if the renter buys it at the end of the contract. This murkiness can intimidate banks and other financial institutions, which can prevent investors from using the equity of a rent-to-own home to finance other deals.

Rental prices are often locked-in, too, just like the purchase price. The inability to raise the rent during the life of a lease can cost real estate investors money. That’s why investors need to set the rent price based on the market’s average performance.

Because this is such a unique purchase option, it’s especially important for investors to hire a real estate attorney to review the contract.