Is Renting-to-Own a Good Idea?

Rent-to-own, or lease purchase, is a legal means of buying a home with a future closing date, usually one to five years from the date of the rent-to-own contract. Until then, the homebuyer rents the home before applying for a mortgage to buy the home. The concept can benefit both homebuyers and home sellers, but there is loss potential, too.

Here’s how it works: The renter pays the homeowner a non-refundable option fee of 1% to 7% of the purchase price of the home. The renter also pays a rent premium above the rental amount, and the rent premiums plus the option fee go into an escrow account that can be used to make the down payment or reduce the sales price of the home. This allows the renter the chance to build up their savings and/or improve their credit history. If all goes as planned, the renter will be approved for a mortgage loan to pay off the seller, but sometimes, buyers lose their jobs or fail to qualify for a mortgage loan and must forfeit the money in the escrow account.

Lease purchase agreements are often used by family members to help a loved one get into a home sooner. They also become more widely used in slower markets, when sellers are having trouble getting the price they want for their homes. Tech companies such as Divvy Homes, ZeroDown, Dream America, and Landis are trying to make homeownership easier by providing rent-to-own homes, advises NerdWallet.