Rent-to-own homes: how they work and the risks

Rent-to-own homes work like this: you rent a house now, and the contract lets you buy it later at a price you agree on today. Some contracts require you to buy. You usually pay an upfront fee and a higher rent, and you can lose that money if you miss a payment or can't get a mortgage.

What kinds of rent-to-own deals are there?

Rent-to-own deals come in two main kinds, plus a contract for deed that sellers often call rent-to-own, which is the riskiest. Sellers don't always use the same names, so read what the contract makes you do, not what it calls itself.

• A lease with an option to buy. You rent the house, and you pay for the right to buy it at a set price before a set date. You can decide not to buy, but you usually lose the fee you paid for that right.
• A lease-purchase. You rent the house, and the contract usually commits you to buy it. Watch for a clause that makes you buy; the Indiana attorney general's March 21, 2022 warning lists it among the terms to look out for. Read what happens to your money if you can't buy.
• A contract for deed, sold as rent-to-own. Also called a land contract or an installment contract. You pay the seller monthly, but the seller keeps the legal title, the official ownership, until you have paid in full. The Consumer Financial Protection Bureau (CFPB), a federal agency, says you usually pay for repairs and property taxes yourself. If you miss payments, the contract often lets the seller take the home back and keep everything you paid.

Where does your money go in a rent-to-own deal?

Your money usually goes to three places, and the contract decides which of them you ever get back:

• The option fee. You pay it up front for the right to buy. Watch for upfront fees you can't get back.
• A higher rent. The Federal Trade Commission (FTC), the federal consumer protection agency, says you may pay more each month than you would to rent a similar home.
• Rent credits. Some contracts set aside part of each payment toward your down payment. Others charge an extra amount on top of rent that doesn't count toward anything.

Example with round numbers. A house is priced at $200,000. You pay a $4,000 option fee and $1,500 a month in rent for 24 months. The contract counts the option fee and $300 of each month's rent toward the purchase. Similar homes nearby rent for $1,200 a month.

In this example, the rent credit happens to equal the extra rent; your contract may credit less, or not count the option fee at all. If you buy, the $11,200 comes off the price, so you still need $188,800, usually from a mortgage. The credits come back to you only if you buy the house. If you don't buy, or the deal ends early, you can lose the $4,000 fee and the $7,200 too.

What can go wrong with rent-to-own?

Buyers often find out too late, the FTC warns, that:

• the "seller" doesn't own the house;
• the owner hasn't paid the property taxes;
• the house is in bad shape, or has lead or asbestos;
• promised repairs aren't made after you sign;
• the house is being foreclosed on, which means the owner's lender is taking it back.

Even an honest deal can go wrong. The FTC warns that in some contracts, one missed payment ends the deal. At the end, you may be locked into a price higher than the house is worth, or you may not qualify for the mortgage you need to finish buying it.

What should you check before you sign?

Before you sign or pay anything, get written answers to these questions:

1. Is the seller's name on the deed, the legal paper that shows who owns the house, at the county office that keeps property records?
2. Are the property taxes paid, and is the seller's own mortgage paid up?
3. What do an inspection and an appraisal, an independent estimate of the home's value, say?
4. Who pays for repairs, property taxes and insurance while I rent?
5. How much of each payment is credited toward the price, and what happens to it if I don't buy?
6. What happens if one payment is late?
7. What kind of mortgage will I need at the end, and can a lender tell me now whether I'm likely to qualify?

For a contract for deed, the CFPB found that buyers often struggle to use their rights because their interest in the home isn't recorded with the county. Ask a lawyer to make sure your contract is recorded.

Do state laws protect rent-to-own buyers?

Some do, and the rules differ by state. In Illinois, the seller of an installment contract must give you an official notice and a copy of the contract at least 3 business days before closing.

In Texas, the attorney general says none of the home's value counts as yours under a contract for deed until you have paid 40% of the loan. Making 48 monthly payments also counts. It also says some Texas buyers lost their homes over one payment that was a few days late. Call your state attorney general's consumer protection office and ask: which law covers my contract, and what notice must the seller give me?

Who can review a rent-to-own contract?

A housing counselor approved by HUD, the U.S. Department of Housing and Urban Development, can give you independent advice, often at little or no cost. Find one near you with the CFPB's housing counselor search, or call the CFPB at 855-411-2372. A lawyer licensed in your state can read the contract itself. Do both before you pay any fee. If a deal looks unfair or dishonest, report it to your state attorney general's consumer protection office.

What are safer ways to own a home?

• Save and build your credit. The FTC suggests saving and repairing your credit first, then buying the usual way with a mortgage.
• Use a housing office's homeownership program. Some local housing offices let a Section 8 voucher, which usually pays part of your rent, help pay a mortgage instead. HUD says it's only for first-time homeowners who have had housing counseling and earn at least a minimum income, the least the office requires you to earn. Only some offices offer it, so ask yours: do you run a homeownership voucher program? See how the Section 8 homeownership program works before you call.
• Join a public lease-purchase program. Some cities rent a home to a likely buyer and help them improve their credit and save. Where a city pays for one with HUD's HOME Investment Partnerships money, the contract must have you buy within 36 months. Your income must also be under the program's income limit, the most a household can earn, when you sign. Ask your city's housing department whether it runs one.
• Buy a home sold below market price. Cities and nonprofits sell some homes at lower prices to households under an income limit. Many use a lottery, a random drawing of names, or a waitlist, a line of buyers served in order. See the housing lotteries open now, and learn how below-market homes are sold.

What should you do next?

1. Before you sign or pay anything, get written answers to the seven questions above.
2. Call a HUD-approved housing counselor to go over the deal, and have a lawyer licensed in your state read the contract.
3. Compare the deal with your other options: check your state's first-time home buyer programs, many of which give down payment help.

To see homes you can apply for now, search homes for sale on our listings page. Use our qualify check to see which ones fit your household's size and income.