By Grant Edrington – Updated: May 11, 2023
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If you’re in the market for a new home and just happened to come across the term “rent-to-own,” it might not mean anything to you. At its most basic level, the phrase means exactly what it says: you rent a property with the intention of owning it later.
But this term has a complicated history and different meanings depending on the context. In this blog, we will discuss how rent-to-own works.
What does “rent-to-own” mean?
Rent-to-own, also known as lease-to-own, is generally an agreement between a property owner and a tenant. The difference between a traditional rental and a rent-to-own agreement is that in a rent-to-own agreement, the tenant has the right, sometimes called an “option to purchase,” to eventually purchase the home.
The requirements of these contracts can vary, but usually, the tenant needs to take some action to secure their right to purchase the home. The term “rent-to-own” itself refers to any such agreement. But as in every type of contract, the details matter a lot.
Historically, these types of agreements were used in a fraudulent and even discriminatory manner. However, in an ideal scenario, they can help renters become homeowners.
The history of rent-to-own
The phrase “rent-to-own” has a long and complicated history. Unfortunately, in some cases, it was used to defraud people and lure them into predatory housing situations. According to The Atlantic, this type of abuse was prevalent in the mid-20th century in some American cities. And sadly, it also continues today.
In an article titled “A House You Can Buy, But Never Own,” author Alana Samuels writes: “In the 1950s and 1960s, African Americans were prohibited from borrowing through traditional means, so they entered into contract-for-deed arrangements, which left them with little equity to pass on to their children.”
That article also quotes Beryl Satter, a history professor at Rutgers University–Newark, who says, “It was bad in the mid-20th century, but it is even worse now… housing is in way worse shape, the markups are grotesque, and these people have been through multiple forms of credit exploitation, which is partially why they’re in this market.”
There are multiple problems with a predatory rent-to-own arrangement like the ones mentioned above. But we know many rent-to-own agreements can be beneficial and legitimate.
How to find rent-to-own homes
While rent-to-own home listings aren’t too common on popular home search sites like Zillow, you can still get into a rent-to-own program by doing the following:
- Work with a reputable rent-to-own program: There are several companies, such as Divvy, that serve as legitimate and trustworthy rent-to-own programs.
- Ask a real estate agent: Some real estate agents are familiar with rent-to-own and may work with legitimate companies such as Divvy as their rent-to-own partner.
- Ask the property owner: If a home is sitting on the market for a while, the seller may be open to considering a rent-to-own agreement. Additionally, if you’re currently renting and wish to own the home eventually, ask your landlord if they’d consider a rent-to-own agreement. In these instances, make sure that your landlord is trustworthy and consider working with an established company or attorney to set up the rent-to-own contract.
Types of rent-to-own contract agreements
There are two types of rent-to-own contracts: lease-option and lease-purchase. Both of these allow you to purchase a home after renting for a certain amount of time in addition to often having monthly savings options and agreed-upon home buyback pricing. However, there are a few key differences to dive into.
The lease-option agreement is generally the more flexible of the two and gives the potential buyer the option to purchase the home before the lease expires. This type of agreement typically requires you to pay the homeowner an option fee when you enter the contract. This usually represents 1-5% of the home’s sale price, which may go toward the down payment if you decide to buy the home at the end of the lease.
Divvy is a lease-option agreement, as customers have the option to walk away (with a 60-day notice1) with no obligation to purchase the home.
The main difference with a lease-purchase agreement is that the potential buyer may have the obligation to buy the home at the end of the lease. While the agreed-upon purchase price and monthly savings options may be part of a lease-purchase agreement, the purchase requirement makes it the more inflexible agreement of the two.
This inflexibility often makes the lease-purchase agreement the less appealing option, as the obligation to purchase remains even if you are unwilling or unable to purchase the home at the end of the lease. This could also create a legal liability for the tenant.
How to rent-to-own a home
While the exact steps for getting a rent-to-own home vary for each person and company, the process tends to follow these steps:
Step 1: Understand your budget and find a home
For many, the first step is to learn how much you can afford and find a home. Financial information such as income, credit score, existing debt, and savings all help determine your home-shopping budget which lets you know which homes you can afford in your area. As you start visiting homes, make sure you get a sense of the quality of the home to make sure you’d be comfortable and safe living there.
With Divvy, you receive a home-shopping budget once you’re approved, can choose almost any eligible home in our metros within your approved budget, and we’ll purchase it with cash. Learn more about what homes are eligible for the Divvy program here.
Step 2: Choose your agreement and purchase price
If the agreement isn’t fully defined from the start, you’ll work with the homeowner or company to set up either a lease-option or a lease-purchase contract. At this time, you’ll also work with the homeowner or company to determine the initial purchase price and the preset purchase price. Before entering into any agreements, we recommend reviewing them and making sure you understand the terms.
It’s common to work with a real estate agent for this step, as they tend to have a good pulse on local home prices and how much to pay for homes in certain neighborhoods. At Divvy, we extend many home offers every day and have deep pricing knowledge on all of our metros. Learn how buyback prices are determined with Divvy at the start of the lease.
Step 3: Determine your option fee and rental term
Next, you’ll agree on an option fee to pay upfront. This tends to be 1-5% of the purchase price of the home and can vary depending on your home-shopping budget, available down payment funds, and home savings goals. You’ll also likely define your rental term, or lease length, at this time. It’s common for lease length to be 1-5 years for rent-to-own agreements.
Divvy usually requires a 1-2% initial payment (this goes toward your future down payment savings2), and our program is designed to help customers become mortgage-eligible on a timeline that works best for them.
Step 4: Pay monthly rent and choose to contribute to savings
Once you’ve chosen the home and agreed on the initial purchase and the option purchase prices, initial payment, and lease length, you’ll start paying your usual monthly rent – part of which may go toward your eventual down payment savings.
Depending on the agreement, you may be able to adjust your monthly savings contributions. For example, eligible Divvy customers can take advantage of flexible home savings.
Step 5: Choose to purchase the home or walk away
At the end of the lease period, or before it, most rent-to-own tenants have the option to purchase the home or walk away. With a lease-option agreement, you have this flexibility and aren’t required to purchase the home.
If you do choose to purchase the home, you’ll probably tap into your monthly payment savings (that have built up over time) to help fund your down payment and/or closing costs. You’ll also work with a mortgage lender to get approved for a home loan. If you choose to not buy the home, you can often walk away with your savings minus some kind of servicing and relisting fee.
Who is rent-to-own right for?
Rent-to-own agreements can be a great pathway to homeownership, especially if:
You could use help saving for a down payment
As long as you’re comfortable with a slightly higher monthly payment, rent-to-own can act as an automatic savings mechanism to build up your savings for an eventual down payment. Additionally, if the home appreciates to an amount greater than your purchase option price, you could gain instant equity in the home.
You need time to improve your credit score
If your credit score is too low to qualify for a traditional mortgage, rent-to-own could be a good option for you given its more flexible qualifications. Many rent-to-own companies also offer counseling and support to get your credit score in a better spot while you prepare to buy.
You’re self-employed or recently got a new job
No matter your income — being self-employed, an independent contractor, or a new hire can make it difficult to qualify for a traditional mortgage. Rent-to-own agreements are often more flexible on income types and can get you into your dream home more quickly.
You want a more competitive, all-cash offer
In a hot housing market, all-cash offers are more appealing to sellers as they often lead to faster closing times and less financing fall-through risk. By working with a rent-to-own company, you may benefit from an all-cash offer that helps you win the home of your dreams.
You’re looking to try a home before you buy it
Rent-to-own can be a great way to try out a new home or neighborhood before you fully commit. While most programs don’t lock you in, make sure you’re aware of any surrender or relisting fees if you do decide to walk away.
How does Divvy rent-to-own work?
Divvy was founded with its mission to make homeownership more accessible to everyone. The best part of our rent-to-own concept is that it places a lot of control into the customer’s hands. As the customer, you know what purchase price you can buy the home from Divvy and at what time. You also know that your savings can grow each month, which will help you purchase the home at a later date. Also, we never lock you in – if life changes, you can walk away (with a 60-day notice) and cash out your savings (minus a 2% relisting fee) with no obligation to purchase the home.
1 In some cases and scenarios, this could be less than 60 days.
2Subject to lender rules and regulations, where applicable.
Grant is a member of the marketing team and focuses on connecting aspiring homeowners in our metros with Divvy. He's worked on marketing teams spanning all parts of the homeownership journey, including home loans, power tools and home improvement, siding and flooring, and now Divvy. Grant graduated from Villanova University and became a homeowner in 2021.