Lease-to-Own vs. Rent-to-Own Properties

Posted by Pam Hill in HousingDecember 15, 2022(Last Updated November 23, 2022)5 min read
Key Takeaways
  • A rent-to-own contract gives renters the right, but not obligation, to buy the home they're renting, at an agreed future date and price.
  • Lease-to-own, also called lease purchase contracts, are similar to rent-to-own, but with an importance difference: the tenant is required to purchase the home.
  •  For those looking to try out a house or neighborhood before buying, rent-to-own and lease-to-own can be great options. 
Are you ready to make some real money moves?

Is There a Difference Between Rent to Own and Lease to Own?

In a word, yes!  While some people use the terms rent-to-own and lease-to-own interchangeably, the terms differ in the level of obligation they impose. A rent-to-own contract gives the tenant an option to buy the home they are renting.  Lease-to-own, also called lease purchase contracts, require the tenant to purchase the home after so many years, or after certain conditions are met. 

 

That said, rent-to-own and lease purchase agreements can be good alternatives for aspiring homeowners who want to purchase a home, particularly for those who may have difficulty qualifying for a mortgage, or who need time to enhance their credit and FICO score to gain loan approval.

 

The Pros and Cons of Rent-to-Own

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Time is on Your Side… 

For those looking to try out a house or neighborhood before buying, rent-to-own can be a great option.  Rent-to-own allows renters to sample the best of both worlds, firmly sitting in the seat of tenant, with no responsibility for property taxes or maintenance costs on the home, and trying on the role of owner, when considering whether to buy the house at the end of the rent-to-own period.

 

A rent-to-own arrangement also provides renters with time to accumulate savings for their down-payment.  This can be especially important for houses costing several hundred thousand dollars.  

 

Lastly, a rent-to-own contract means that the renter has first-dibs on the house, should they choose to make it their forever home.  Not only will the renter be first in line ahead of any other offers, but the renter will know exactly what the sales price of the house will be, as this will be stipulated in the rent-to-own agreement. 

 

 

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… But it Comes at a Cost

Rent-to-own contracts require that you pay not only your rent each month, but also a small payment towards your down payment.  If, for instance, your monthly rent is $1,200, the rent-to-own agreement might require that an additional $200, or a total of $1,400 is paid each month.  The incremental $200 payment, called a rent credit, would be held in escrow as money towards your down payment, should you choose to buy the home.  As an example, if the rent credit is paid for three years, then at the end of year three, the tenant would have $7,200 in escrow to apply towards the down payment for their mortgage.

 

Rent credits, however, don’t accrue to the tenant if the tenant doesn’t buy the home. If the tenant decides that they would prefer to remain a renter, or to move from the house altogether and not purchase it, the rental credit will be forfeited and retained by the landlord as additional rent.

 

A second downside of rent-to-own is that the pre-set price of the house might, in retrospect, look like a bad deal for the renter when it comes time to buy.  If housing prices fall between the date the rent-to-own agreement is signed and the expiration date, the renter will be loathe to make good on the sales agreement, which will reflect a price that is too high relative to market price.  Of course, if housing prices rise precipitously, the buyer will rejoice at the immediate equity that will accrue upon sale.  

 

A final risk of rent-to-own agreements is that the renter might lose their right to purchase the home because of a breach in the lease. Imagine that the lease stipulates that no pets are allowed, and on a whim, you adopt a kitten that’s just as cute as a button.  While the landlord might not have anything against kittens per-se, you have breached the lease by bringing one into the home without obtaining the written permission of the landlord and amending your lease.  Depending on your landlord, this breach might be cited as not only a breach of the rental agreement, but also your rent-to-own rights, leading you to forfeit the rent credit and your right to purchase the home. 

 

The Pluses and Minuses of Purchase Lease Agreements 

In many ways, purchase lease agreements are quite similar to rent-to-own agreements, with many of the same features, pros and cons.  For instance, when a tenant seeks to buy a house through a lease purchase agreement, the tenant and landlord agree to a pre-set sales price for the home, at some specific future date.  As an example, if a lease purchase agreement is signed on December 1, 2022 and has a three-year lease period and home sales price of $300,000, this means that the renter commits to buy the house at a sales price of $300,000 on December 1, 2025.  

 

One of the biggest potential downsides in a lease purchase agreement is that the tenant is bound by contract to purchase the home at the pre-set price rather than merely having the option to purchase it.  If a tenant does not honor the commitment to buy upon the agreed date, the landlord’s recourse includes the right to take the tenant to court and sue for costs that the rental credit do not cover. 

 

A second downside of a lease purchase contract is that the tenant is often responsible for paying for property taxes and maintenance expenses that would ordinarily be the landlord’s responsibility.  As a for instance, has the furnace decided to stop working on the coldest night of the year?  That’s now a you-problem rather than a landlord-problem. 

 

A significant benefit of a purchase lease agreement is the ability for the renter to finish the lease term with a hefty down payment saved, by simply paying rent. The required rent credit for purchase lease agreements can be higher than for rent-to-own, giving the tenant a built-in monthly savings mechanism for their down payment. 

 

Additionally, since the tenant has more certainty that they will buy the home versus with a rent-to-own property, the tenant might be able to obtain concessions from the landlord in the form of upgraded appliances in the home, or permission to add design flourishes while living as a tenant, more in line with the renter’s tastes. 

 

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Define The Details

Whether you buy a home through  a rent-to-own agreement or a lease purchase, details matter.  Take time to define the rent terms and conditions, purchase price, purchase date, down payment and rent credit.  The typical terms of a lease purchase or rent-to-own agreement is one to three years— long enough for the tenant to save towards the down payment and short enough for the sale price to still be in the ballpark and leave both sides feeling that it is fair on the purchase sales date. The incremental payment made towards your down payment, is usually not refundable, however, this should be approached in the spirit of negotiations with your landlord. 

 

Rent-to-own and lease purchase agreements are binding contracts.  Any concessions or changes to the agreements should be made in writing and not verbally. Similarly, both the landlord and tenant should hire an attorney to review the agreement before agreeing to be bound by its terms and conditions. 

 

 

The Bottom Line

A rent-to-own or lease purchase contract can provide a good alternative when poor credit or an insufficient down payment stand in the way of obtaining a traditional mortgage loan. Renting-to-own can also provide a solution if you want to purchase a home, but hope to test out the neighborhood and evaluate it through the eyes of an owner before committing.

 

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