The clear majority (80 percent) of American millennials plan to buy a home one day, according to a study from Apartment List. But, over two-thirds of them have saved less than $1,000 for a down payment. Nearly half (44 percent) haven’t saved anything yet.

For aspiring homeowners who don’t have enough money to cover the upfront costs, or those battling a poor credit score, rent to own agreements are enticing. Before you start a rent to own search, consider the terms, advantages and potential drawbacks involved.

How Does Rent to Own Work?

There are two primary types of rent to own agreements. The most popular is called a lease agreement with an option to purchase. The tenant pays a fee at the start of their lease that gives them the opportunity to purchase the home down the road. If the tenant decides to buy, the option fee is put toward the purchase price. Otherwise, they forfeit the money fronted. Option fees range anywhere between 2 and 7 percent of the agreed-upon purchase price.

A lease purchase agreement is a bit more binding. It states that the tenant and landlord agree upon a purchase price when signing the lease, or at least commit to a future appraisal and closing date with a sales price to be determined.

The Pros of Rent to Own

Rent to own contracts are beneficial for tenants who’ve found the home of their dreams but aren’t quite ready to commit, whether they need more time to build their credit or save for a down payment to qualify for a home loan.

  • Provides the tenant exclusive right of refusal (i.e. first dibs), and in competitive markets, eliminating stressful situations like bidding wars.
  • Lease purchase agreements may also help you lock down a lower purchase price compared to what you would pay in a few years, especially in areas where home values are quickly appreciating.
  • Sometimes, the landlord (prospective seller) will apply a portion of your monthly rental payments toward the purchase price, should you choose to pursue the sale. Unlike a normal 12-month lease, your rent payments aren’t just “going down the drain” or lining your landlord’s pockets. For example, a lease purchase contract ($2,500/month) with set sales price ($450,000) states 25% of total rent over a two-year lease is credit back at purchase. The tenant-buyer receives a $15,000 credit at purchase while building equity in the home prior to closing.
  • Since you’ve provided security of purchase (via fee), many owners will allow you to make changes or upgrades without asking permission. Tenants of rent to own properties often renovate without losing their investments at lease end.

The Cons of Rent to Own

On the surface, it appears your landlord is doing you a favor by putting a portion of your rent toward the purchase price. But, it’s important to ask your agent what the rent would likely be with a standard lease. If your landlord agrees to credit you back 25 percent, but the rent is 25 percent higher than the unit’s market value, the landlord is cushioning those purchase credits into the market rent. Rent to own tenants often do not receive any free equity or a rent price discount.

There’s also maintenance and repairs. In a normal lease, the landlord is responsible for most of the upkeep, but that’s not always the case in a rent to own agreement. Don’t forget to set up an emergency savings budget if home repairs fall on your shoulders.

The biggest drawbacks of rent to own contracts are for tenants who have second thoughts. While the lease agreement with an option to purchase does not obligate you to buy, you most likely won’t see your option fee back. You also risk losing any rent surplus that was due to be credited toward the purchase price. If you back out of a lease purchase contract, you could be sued for specific performance.

Full disclosure: rent to own transactions are few and far between in the Chicago housing market, but understanding your options just in case the opportunity arises is never a bad idea. Most of the time, rent to own condos are not advertised. The contract is usually drafted upon request, so long as it makes financial sense for both the landlord and the tenant alike.

Keep in mind, if your primary obstacle of home buying is saving for a down payment, you might consider a low down payment mortgage (less than 20 percent) or down payment assistance program. Call Z Chicago at 312-810-2295 to discuss your first-time home buyer options today.