Over the last several years, many Americans have become pessimistic on the prospect of home ownership.
According to a recent Bankrate survey, 51 percent of aspiring homeowners view cost-of-living issues as a major obstacle to buying, while 54 percent say their household income hasn’t matched the rise in market prices for available homes.
With those challenges in play, many people are exploring rent-to-own options. Renting to own involves leasing a home for a set period before purchasing it. It’s an arrangement that allows potential buyers a way to accumulate savings for a down payment, build equity and improve their credit score while living in their desired home. It is often a far more affordable route to ownership for people with little money for a down payment or with credit scores that don’t yet qualify for conventional loans.
If rent-to-own sounds like an appealing alternative to conventional home ownership, it’s best to fully understand the process—including advantages, disadvantages, types of contracts, and considerations—before deciding if it’s the right choice for you.
The Basics
The idea behind rent-to-own is that the occupant of a home starts as a renter and eventually becomes the home’s buyer. The process is governed by legal agreements with several key components:
- Option Fee. This up-front fee secures the renter’s right to buy the home at a later date. Typically ranging from 1% to 7% of the home’s purchase price (rather than the customary 20% often required in a conventional purchase), this fee is non-refundable.
- Monthly Rent. Like a standard rental agreement, the agreement requires a regular monthly rental payment.
- Rent Credit. By contrast to a standard rental agreement, a portion of the monthly payment is placed in an escrow account.
At an agreed-upon point in time, the accrued rent credits plus the initial option fee will be applied toward the purchase of the home either as a down payment and/or a reduction in the price of the home.
Contract Types
Depending on the home being bought, a rent-to-own contract will typically be one of two types:
Lease Option. A lease-option agreement allows the renter to decide, upon expiration of the lease, whether or not to buy the home.
If the renter elects to buy, the option fee is often applied toward a reduction in the negotiated price of the home, while the accrued rent credits are applied toward the down payment. If the renter declines to buy, the option fee and rent credits are forfeited.
Lease Purchase. By contrast to a lease-option contract, a lease-purchase contract obligates the renter to buy the home at a price agreed upon in advance.
While this more rigid option leaves little room for a change of mind when the lease term is up, it also takes full advantage of a hot housing market in which the value of the home is likely to be higher at purchase time than the agreed-upon price — allowing the buyer to build equity while renting.
Is Rent-To-Own Right For Me?
The rent-to-own option might not make sense for every buyer, but it can be a great option depending on your circumstances:
Cash-strapped. If you’re keen on home ownership, but you don’t have the cash for a traditional down payment, rent-to-own may be the way to go.
With the lower entry cost of an option fee, rent-to-own may allow you to get into the home you want without waiting to scrape together a 20% down payment.
Poor Credit. People with poor credit can also benefit from rent-to-own arrangements since the qualifications are often less demanding than traditional mortgages.
By locking in a home for the duration of the lease agreement before buying it, rent-to-own allows the buyer to improve their credit score before applying for a mortgage.
Still, it’s vital to bear in mind: housing markets go down as well as up. As with all real estate transactions, it’s critically important to understand contractual terms and financial implications, so getting competent legal advice before signing a rent-to-own contract is always recommended.
Pros and Cons
If you’re considering taking the rent-to-own route to home ownership, there are pros and cons to keep in mind.
Advantages include:
- Structure. Savings discipline is built into the contract to ensure a down payment.
- Equity. Buyers can benefit from rising real estate values.
- Affordability. Low entry costs can make otherwise out-of-reach homes financially accessible.
- Credit. Lease periods can give time to repair or build damaged or insufficient credit scores.
Disadvantage include:
- Budgetary Strain. Due to the inclusion of rent credit costs, rent-to-own can put greater strain on a monthly budget than a simple rental.
- Risk of Loss. Lapse or breach of contractual arrangements can result in the permanent and unrecoverable loss of both the option fee and any accrued rent credits.
Make Sure You Are Covered
At the successful end of a rent-to-own journey, you’ll be able to congratulate yourself on the considerable accomplishment of becoming a homeowner.
During the transition from renter to owner and beyond, you’ll need the protection and peace of mind that only a solid insurance plan can provide: first with renters insurance and ultimately with homeowners coverage.
Talk to a local insurance agent today, and we’ll help you find the right coverage no matter where you are on your journey to home ownership.
ERIE® insurance products and services are provided by one or more of the following insurers: Erie Insurance Exchange, Erie Insurance Company, Erie Insurance Property & Casualty Company, Flagship City Insurance Company and Erie Family Life Insurance Company (home offices: Erie, Pennsylvania) or Erie Insurance Company of New York (home office: Rochester, New York). The companies within the Erie Insurance Group are not licensed to operate in all states. Refer to the company licensure and states of operation information.
The insurance products and rates, if applicable, described in this blog are in effect as of October 2024 and may be changed at any time.
Insurance products are subject to terms, conditions and exclusions not described in this blog. The policy contains the specific details of the coverages, terms, conditions and exclusions. Your ERIE agent can offer you practical guidance and answer questions you may have before you buy.
