How Rent-to-Own Agreements Work: Option Fees, Rent Credits, and Risks

A rent-to-own agreement lets you rent a home now and buy it later at a price set in the contract. You usually pay an upfront option fee and sometimes extra monthly rent that is credited toward the purchase, and you can lose both if the sale never closes. Mortgage lenders may count only part of those rent credits, the owner's own mortgage can end the deal, and your protections come mostly from the contract unless your state regulates these deals, as Texas does.

Lease-option or lease-purchase: which one are you signing?

Check which of these you are being offered, because each one handles a failed purchase differently.

If you sign a lease-purchase, ask for a financing clause that ends your duty to buy, and returns your option money, if a lender turns you down after a good-faith application.

State laws on contracts for deed differ. In Ohio, for example, once the buyer has paid for 5 years or paid 20% of the price, Ohio Revised Code section 5313.07 requires the seller to go through foreclosure and a court sale to take the home back, instead of simply canceling the contract.

What the option fee and rent credits cost

The option fee is the price of the option itself, paid when you sign. For example, a 3% fee on a $300,000 price is $9,000. Because it buys the option, you generally do not get it back if you decide not to buy, unless the contract says otherwise. Check whether the contract credits it toward the price at closing.

Rent credits are the part of each month's rent the seller agrees to apply toward your purchase. Say your rent is $2,300 and the contract credits $300 a month for 24 months, or $7,200.

What a lender will count. For loans it buys, Fannie Mae lets the rent credit go toward your down payment only up to the difference between the rent you actually paid and the market rent, as set by the home's appraiser. The lender must document:

1. A lease with an option to purchase that had an original term of at least 12 months and shows the monthly rent and monthly credit.
2. Proof of each rent payment, such as canceled checks, bank statements, or money order receipts that show the payee and the amount.
3. An appraisal that states the market rent.

If the appraiser sets market rent at $2,100, the lender can count $200 a month ($2,300 minus $2,100), or $4,800 over 24 months, not the $7,200 the contract promised.

A low appraisal can raise your down payment. Fannie Mae measures a purchase loan against the lower of the sales price or the appraised value. If your locked price is $300,000 but the home appraises at $285,000, a loan you planned at 95% of value is capped at $270,750 (95% of $285,000), so your down payment grows from $15,000 to $29,250 ($300,000 minus $270,750).

When you can lose the money you paid

Read the contract for each of these events:

• The option deadline passes before you meet the contract's requirements to exercise your right to buy, including any required notice. This deadline can differ from the closing deadline.
• You cannot get a mortgage and the contract has no financing clause.
• You default on the lease, if the contract says a default ends the option. In Texas, a contract cannot take away your option fee because of a late payment.
• The owner loses the home to foreclosure.

Track both deadlines and your credits in writing, and keep proof of every payment in the form Fannie Mae requires, so the credits you earned can be documented later.

Who handles repairs?

Find the clause that says who pays for repairs and maintenance before you sign. If it puts them on you, budget for them as an owner would, and get a professional inspection first so you know what you are taking on.

Texas sets a floor. The lease part of a lease-option is covered by the state's residential landlord-tenant law (Chapter 92), which includes the landlord's repair duties, and the seller cannot raise the price, charge a fee, or otherwise penalize you for requesting repairs or using your other rights under that law. Under Texas Property Code section 5.0621(b), Chapter 92 stops applying once you exercise the purchase option, which can happen before closing.

What if the owner stops paying the mortgage?

If the owner stops paying, the lender can foreclose, whatever your contract with the owner says. Two federal laws shape what happens next:

• Due-on-sale clauses. A due-on-sale clause lets the lender demand full payment if the owner transfers an interest in the home without the lender's consent. The Garn-St Germain Act stops lenders from using it for a lease of 3 years or less only when the lease has no option to purchase, so a lease-option, or any lease over 3 years, does not get that protection, and the owner's lender may be able to call the loan due.
• Your right to stay after foreclosure. Under the Protecting Tenants at Foreclosure Act, the new owner must give a tenant with a bona fide lease, signed before the foreclosure, at least 90 days' notice to leave and must honor the lease to the end of its term, unless the home is sold to a buyer who will live in it. A lease counts as bona fide when it was made at arm's length (on ordinary terms between parties acting independently), the rent is not far below market, and the tenant is not the owner or the owner's child, spouse, or parent. The law protects your right to live there, not your option to buy.

Texas goes further. Texas Property Code section 5.085 requires the seller to own the home free of liens, with one exception written into the statute: the mortgage the seller used to buy the home, which is allowed only if the seller:

1. Gives you a separate written notice, at least 3 days before signing, with the lender's name and contact information, the loan number, the balance, the monthly payment, and a warning that missed payments can lead to foreclosure.
2. Has a lender that allows the arrangement and agrees to confirm the loan's status for you and to accept payments directly from you if the seller defaults. The lien must cover only this home, and the loan balance can never exceed what you still owe the seller.
3. Promises in the contract to pay on time, send you monthly statements, and tell you within 3 days of any default or foreclosure notice. If the seller misses a payment, you can pay the lender and subtract 150% of that amount from what you owe.

A seller who breaks this rule lets you cancel and get back all your payments, plus reimbursement for property taxes you paid and the value of improvements you made. Texas applies these lien rules, the late-payment and repair protections, and a 30-day notice and right to cure before forfeiture to every residential lease-option (Texas Property Code section 5.062). Contracts longer than 3 years also get seller disclosures, a 14-day right to cancel for any reason, recording within 30 days, and a yearly account statement.

Outside Texas, ask the owner for the latest mortgage statement and for written permission to check the loan's status with the servicer (the company that collects the mortgage payments) before you sign.

Steps before you sign

1. Have the contract reviewed. HUD-approved housing counselors advise on buying a home, often at little or no cost, and a real estate attorney can review the contract terms.
2. Ask a lender what you would need to qualify at the end of the lease, including the credit score, income, and down payment, and whether it will count your rent credits.
3. Budget for the full monthly rent, not the rent minus credits; our guide to how much rent you can afford shows how to test the payment against your income.
4. Build your credit while you rent. Our guide to rent reporting explains how on-time rent can reach your credit report.

For due dates, grace periods, and late fees while you are renting, see our overview of rent payment rules for tenants.