Rent-to-own agreements allow home buyers to get a foot in the door. They appeal to people who need more credit or time to save for a down payment.

But before you sign a rent-to-own contract, ensure you understand what you’re getting into. And avoid falling for some of the common traps.

The Basics

A rent to own home is a property you can live in with the option to purchase later. This allows you to build equity in the home without having to make a large down payment or qualify for a mortgage.

Two main types of contracts are used with rent-to-own homes: lease-option agreements and lease-purchase agreements. Both are used in different situations, but both must be drafted carefully.

Generally, these contracts require you and the tenant to agree on a home price and lease period. The renter will also need to keep a portion of their rent payments in an escrow account until they can purchase the home.

Before you sign any contract, research it thoroughly and review it with a real estate attorney. This is especially important for rent-to-own contracts because they can vary greatly from normal rental agreements.

Financing

A rent-to-own contract may be your best option if you’re looking to buy a house but need more cash for a down payment or a good credit score. These agreements allow you to save a portion of your monthly rent toward a future down payment, which helps you take those first steps to homeownership.

A rent-to-own home works best when it’s a solid deal for both parties. Make sure you know exactly what you’re getting into and work with a reliable seller, especially if your credit still needs to be in the best shape.

The lease term will vary, but typically you’ll rent the home for one to three years. At the end of that time, you’ll have the option to purchase it for the amount owed. If you choose to do so, you’ll have to pay an upfront fee called the option money or an option fee, usually between 1.5% and 7% of the home’s purchase price.

Contracts

Rent-to-own agreements are not like typical rental contracts, and they may include legal stipulations you should know about before signing one. These contracts can be confusing, so it’s always a good idea to read the fine print and talk to a real estate lawyer.

In most cases, a rent-to-own contract will give you the option of buying your first home at the end of your lease term. It will also let you apply a portion of your monthly rent payments toward your down payment if you decide to purchase the property.

However, you could lose this option if you don’t qualify for a mortgage at the end of your lease term.

Traditionally, rent-to-own contracts have been designed to benefit people who don’t qualify for conforming loans or need help saving for a down payment. This is especially true in high-priced real estate markets where jumbo loans are common.

Payments

It’s common for a lease to include the ability to buy a home in the future at an agreed-upon price. This is often referred to as a rent-to-own or RTO. Doing your research before signing on the dotted line and getting the legal nitty gritty in writing is a good idea. In addition to the usual rental payments, you might also be required to make a one-time upfront option fee. Depending on the deal, it could be anywhere from 1% to 5% of your future purchase price. Luckily, many big names offer consumer help resources like credit counseling and repair. This could be smart if your budget is tight or your credit rating is on the skids.