The problems with Rent to Own

Please, pick one or the other.

Oh, rent-to-own. You sound so attractive, but you're so misconstrued. I get many calls from renters, often those with weak credit or low-paying jobs, who have seen the term "rent-to-own" tossed around. Seeing that I'm a Realtor who works in rentals, they figure I must do a ton of these. They are usually surprised when I immediately launch into a full-on campaign to talk them out of the idea. It's just a terrible arrangement for both the landlord and the tenant unless you are so bad at saving money that you simply cannot put together a down payment in any other way.

Fluctuations Hurt Everyone.

First of all, prices change over time. This means that an agreement like this where the purchase price is set at the beginning of a 3-5 year lease is going to wind up screwing somebody over. If sale prices go up, the landlord gets hurt by being locked into the old low price. If prices go down, the tenant gets cheated out of some cash and may not be able to close the deal if the property doesn't meet or exceed the value of their new mortgage once the time comes to hand over the title.

Give a Yard, Get an Inch

Secondly there's the typical structure of a rent to own agreement. The chart below, while simplified, illustrates the difference between the common perception of "rent to own" on a $1000 apartment, and the reality of the situation.

Based on $1000 rent rate.

Not quite what you had in mind, was it?

There's a lot of restrictions on a rent-to-own. You have to take into consideration the landlord, the mortgage lender, and your own needs. If someone has a property on the market it means they want to get rid of it. They don't want to hang around for 3 to 5 years waiting for you to buy it. They want it gone now. By pulling it off the market for you for 3-5 years even in an appreciating market they may lose out on a buyer who does want to buy it from them now. They will want to charge you for keeping the property out of the sales market. This is called the "option amount" and it gets tacked on to the regular fair market rent. So you're now paying $1200 for that apartment. $1000 in rent and $200 for the option.

Meanwhile, once your rent-to-own time period comes to an end and you're looking for a loan to complete the purchase, a lender will look at the market rents for that building. Only the amount in excess of the fair market rent will be considered as eligible to go towards the down payment. If you're lucky, they might assess the fair market rent at $800, meaning that you've got $400 left that the bank will let you allocate.

Of course, your landlord may also have a say in the down payment allocation matter, too. After all, they'll have to hold on to the amount earmarked for down payment until the actual sale occurs several years down the road. They can't use it for today's expenses. Many will let you contribute only 20-25% of your monthly rent payment towards a down payment. The rest needs to go towards operating costs.

Get A Yard, Feel the Pinch

There's also the issue of maintenance. Many landlords get sold on the idea of a rent-to-own deal because they think a prospective buyer will take better care of their property than your run of the mill tenant. Some landlords take this even further and fob a lot more of the maintenance over to their renters. Suddenly items like landscaping, snow shoveling and basic repairs are dropped in your lap. I've seen some landlords work out something very similar to a deductible, which their tenant must contribute towards repairs before the landlord kicks in to assist with the cost.

Rent-to-own agreements are generally outside of the province of the Chicago Landlord Tenant Ordinance. You're pretty much on your own, relying on whatever is included in your lease & rent-to-own contract. Needless to say, you want to get attorneys involved very early on in this process.

Collateral Damage

A security deposit equivalent to about one month's rent is expected in apartment rentals. While some larger landlords are moving away from the deposit, you'll still have to put up some sort of collateral against damage to the unit before you move in. In most cases of normal rentals, the deposit is the maximum you would forfeit upon moving out, unless you leave behind an enormous rent balance or massive damage better served by an insurance claim.

In the case of a rent-to-own, the option amount is generally not refundable. It is definitely held in escrow so that the landlord doesn't spend it before the title transfer occurs, but if you don't exercise your option to purchase at the end of the lease period the landlord will keep it. This means that if you choose to walk away from a rent-to-own without buying, your forfeited collateral could be far worse. Check out the difference in the chart below.

Based on $1000 deposit, $200 option add on, 3 year lease prior to purchase.

There are different tiers of rent-to-own agreements that may have far more stringent penalties. In a Lease Option agreement, the option is at risk as shown in the chart above. In a Lease Purchase agreement, the landlord might also be able to force you by lawsuit to buy the property when the rental period is over. So, unless you're absolutely serious that you want to live in this home for at least 8 years (3-5 as a renter plus 3-5 as an owner) you should only enter this kind of agreement with extreme caution and the advice of an attorney and agent who have done it successfully before.

Cultural Predation

The rental-purchase market for goods other than housing is pretty darned pervasive among certain subsets of the population. The FTC did a survey in the late 1990s and reported that the majority of customers using rent-to-own as a purchasing option were young, poor, and black. Most do not have more than a high school education.[1]James M. Lacko, Signe-Mary McKernan, and Manoj Hastak, Survey of Rent-to-Own Customers, January 2000,

Those who are culturally accepting of rental-purchase as a viable route to ownership of furniture, electronics, etc. will be far more likely to enter into these financially unsound agreements when it comes to housing as well. I don't know about you guys, but anytime I see a purchasing structure targeting the poor and inexperienced members of the population I get really suspicious. A dishonest property owner stands to gain a lot more in retained collateral from a buyer who is very eager to purchase but unlikely to be able to close the deal.

The FTC had to nose in on the affairs of rent-to-own businesses even when it was on the smaller scale of renting furniture. That's with large, obvious companies that rely on large numbers of consumers paying small amounts. A home seller, on the other hand, can fly under the FTC's radar and needs the approval of only one person - you - in order to make quite a bit more than you'd spend on a couch. Caution is needed.

Something Closer

When most people picture a rent-to-own scenario, if it's anything like the "Imaginary" section of the bar chart I drew above, they're may be thinking of seller financing. In the case of seller financing, the title changes hands up front, but instead of going to an outside bank to obtain a loan, the seller allows the buyer to pay off the purchase in installments with interest. Here's a table that explains the differences.

Rent to OwnSeller Financing
Title transfer occurs at end of lease period. Title transfer occurs up front, at least in part.
Buyer must obtain an outside loan. Seller is the originator of the loan.
Property must appraise at or above the amount of the loan. No appraisal required.
Purchase or loss of option money required at end of rental period. After 3-7 years, balloon payment of loan balance required.
Only the amount in excess of fair market rent goes towards the purchase price. Entire payment, less interest, goes towards purchase price.
Standard down payment allowances apply, as you're applying for a regular loan. Seller will very likely require 20% down payment up front.
You can build up your credit to become loan-worthy while living in the unit, if the landlord is amenable. You'll probably need excellent credit right off the bat to convince the seller that you'll honor the debt.

Obviously neither is a magic bullet for a buyer with weak credit and no savings. One commits you to a very long term arrangement at a pricey premium. The other requires you to be ready to buy up front, but allows you to wiggle around low appraisal amounts and conforming loan maximums.

Preferred Method: Self Control

There will always be homes on the market. In fact, if you're planning on renting-to-own, chances are good that the same property you want to rent-to-own now may well come back on the market in 5-7 years anyhow. Who's to say that it will still suit your needs? Come to think of it, considering that only a small subset of owners are willing to do lease-purchase or lease-option agreements anyhow, who's to say that any of their properties will suit your needs in the first place?

If you aren't ready to buy now, paying a costly premium to rent-to-own will not help matters. You need to be both financially and mentally ready to take on the responsibilities of homeownership. Better to set up a mandatory monthly transfer to an outside savings account to build up your down payment, find a cheaper apartment and focus on rebuilding your credit score on your own. You'll be far more confident in yourself and in a stronger negotiating position after 3-5 years if you are able to demonstrate the necessary self-control to do it this way. You'll have learned the money-saving skills necessary to keep your home for a good, long time.


1 James M. Lacko, Signe-Mary McKernan, and Manoj Hastak, Survey of Rent-to-Own Customers, January 2000,