How does Rent to Own work?

How rent to own works

Lease Agreement or Purchase Agreement?

How about both? The heart of rent to own arrangement is that you are agreeing to both. These two elements of rent to own agreement may be included in one agreement (or contract) that the parties sign, or can be separated to two separate agreements Here is how it works:

Purchase Agreement

First component of rent to own is the purchase agreement. More precisely, it is a purchase option agreement. The buyer and seller are agreeing that the buyer has an option within a set period of time, which is called the "term" of say 5 years, to purchase the home for the price that is agreed to at the time of rent to own agreement. Typically, the buyer can exercise this purchase option at any time during the term of the agreement.

Lease agreement

Until the buyer exercises the aforementioned purchase option, a lease is put in place. The lease part of rent to own agreement is similar to any other lease agreement, with a few possible exceptions. For example, the agreement may allow the tenant/buyer to do more work on the house or may put some maintenance responsibility on the tenant/buyer.

Monthly Payments

The monthly payment for rent to own is a combination of rent and purchase option mentioned above. Most likely, it is a single payment and often is designated simply as rent. It it typically 10-30% higher than the rent price of comparable home in the same market. Some times, part of the monthly payment is set aside as "savings" towards the down-payment of the eventual purchase of the home. Whether such financial arrangement is part of the deal or not is up to the terms agreed to between the seller and buyer.

Example

It is easier to illustrate a rent to own deal with an example. Let's say Jen and her family has found a rent to own home in Los Angeles, CA. The home is priced at $500,000 with a "lease option" an indicator that rent to own is available. Jen may agree to the following terms with the home seller

  • 5-year term
  • Jen may exercise her purchase option any time within th 5 year term
  • Monthly price includes rent and purchase option, but no savings toward down-payment
  • Monthly payment is $3,200 (a similar home in the area may rent for $2,600 to $3,000)
  • If Jen exercises her purchase option, the purchase price would be:
    • $510,000 within first year
    • $530,000 in year 2
    • $550,000 in year 3
    • $570,000 in year 4
    • $590,000 in year 5

The prices listed above would be fixed no matter what the real estate market does. Even if the home prices double in 4 years, for example, the price would still be $570,000. Of course, the opposite is true as well.

Next, see if rent to own is right for you.