What to know about ‘lease with option to buy,’ or rent-to-own homes

With mortgage rates topping 6 percent and home prices that are still riding their pandemic spike, homeownership may seem out of reach for many people these days. If you dream of buying a home despite the affordability crunch, what options do you have?

Renting a home with the intention to eventually buy it — rent-to-own, essentially — is one thing to consider. This type of contract can help people who want to buy but aren’t quite financially ready yet, providing extra time to save down payment funds and shore up credit scores until they can make buying a reality.

What is a lease-option-to-buy?

A lease option is a contract in which a landlord and tenant agree that, at the end of a specified period, the renter can buy the property at a specified price. The tenant pays an up-front option fee and an additional amount each month that goes toward the eventual down payment.

You may hear lease option contracts called by a variety of other names, but they all mean essentially the same thing: rent-to-own agreements, rent options, lease-to-buy options, rent-to-buy options, lease with option to buy or lease with option to purchase.

Each contract will differ, but typically, if you decide not to purchase the home at the end of the agreement, you’ll lose your option fee and potentially also any money you put toward a down payment.

This type of housing situation may sound unusual, but it’s easier to find than you might think. There are many companies devoted to facilitating rent-to-own housing, including Divvy and Home Partners of America.

Questions to ask about lease with option to buy

Lease-with-option-to-buy contracts can be complicated, so make sure you’ve answered the following questions before moving forward:

1. How is the deal structured?

Make sure you understand all of the terms of the deal, including the length of the agreement and the amount of the option fee. (It could be any amount, from a few hundred dollars to a full 20 percent of the value of the home.) Typically, you’ll pay above-market rent, with a portion of that amount going toward your future down payment on the property. It’s smart to seek the advice of a real estate attorney who has experience with these agreements and can look over the contract before you sign it.

2. What’s my plan to prepare for the purchase?

“When you do a lease option, you’re betting that you’re going to qualify for a mortgage and be able to execute and buy the property,” says Timothy McFarlin, a California real estate attorney. “Make sure you have a path to do that.”

Talk to a mortgage lender before entering into the lease-option-to-buy agreement, so that you know about how much money you’ll need to cover a down payment and closing costs later on. In addition to amassing a down payment, use your time renting to improve your credit score. A higher score will allow you to qualify for the best possible rate when it’s time to buy the home. In other words, pay down your debt, avoid opening new credit accounts and pay all of your bills on time.

3. How is the housing market in my area?

In most cases, either a purchase price is agreed to in advance or it’s spelled out that the eventual price will be contingent on a home appraisal at the time of sale. Home values can fluctuate during your lease period, so it’s important to know if the price can be adjusted before you buy.

In a market where home prices are on the rise, it can benefit the buyer to lock in a price in advance. But in a market where prices are falling, be careful — you may end up agreeing to pay more than the home will be worth at the time of purchase. In that scenario, you might have a harder time getting approved for a mortgage or assembling a sufficient down payment plus closing costs.

4. Who’s responsible for what?

The lease-option contract should spell out whether the renter or the landlord is responsible for the maintenance and repairs of the home, as well as who is going to pay for utilities and any homeowners association fees. You’ll need to secure renter’s insurance, and the owner is responsible for having landlord’s insurance.

5. Do I need a home inspection?

As with any home purchase, it’s critical to get a professional home inspection to ensure you’re making a sound investment. It will cost a few hundred dollars, but it’s worth it to ensure a property doesn’t have major red flags. If the inspection report uncovers costly problems, be sure to work out when those repairs will take place and who’s going to pay for them.

6. Have I considered other options?

If your finances are unstable or you’re not sure you’ll really be able to purchase the home at the end of the lease period, you might be better served with a standard rental. Meanwhile, take time to work on your credit and get your finances in better shape so you can strike when the time’s right. After all, it’d be a waste to plunk down extra money on a lease-option and above-market rent without making any meaningful progress toward homeownership.

Kimberly Cole, community engagement manager at Navicore Solutions, a nonprofit financial counseling company, suggests that potential buyers look into down payment assistance programs in their area. “The terms of those programs might serve you better and give you an opportunity to buy right away, as opposed to being beholden to a landlord for a time,” she says.

Pros and cons of lease-to-buy homes

There are benefits and drawbacks to entering a rent-to-buy contract:

Bottom line

A lease-option-to-buy arrangement can be a useful solution for potential homebuyers, especially if you love a particular home but could use some extra time to save up more and increase your credit score before securing a mortgage. It’s not without its risks, though. If you think it makes sense for you, ask a real estate attorney to look over the paperwork and walk you through the agreement before signing on the dotted line.