What is the difference between rent to own and renting

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While we strive to provide a wide range offers, Bankrate does not include information about every financial or credit product or service. As home prices continue to rise, those with their heart set on homeownership may be starting to explore less-traditional options to climb onto the property ladder.

One such option is a rent-to-own agreement, a method of buying a house by renting it first. A rent-to-own home is one that allows for a tenant to rent the property, but also gives the tenant the option to buy it before the lease expires. Through rent-to-own, tenants can effectively test-drive a home, living in it for a period of time before they choose to buy it, while the owner of the home can use the purchase option to lock in a sale price, and also find a higher-quality tenant.

A typical rent-to-own arrangement has two parts: the rental lease agreement and the purchase option. The purchase option gives you the right to buy the home during or at the end of your lease. You might need to pay an upfront fee to have this option included in the overall agreement, depending on the market. Rent-to-own is a way to buy a house by renting it first. In many arrangements, some of your monthly rent payment gets applied to the final purchase price.

Both parties must agree on the purchase price, which can be tricky when the sale is happening several years in the future. In a rising market, for example, the seller might want the buyer to pay more than the current value of the property.

Some contracts state that an appraiser will determine the price of the house at the time of purchase. The buyer then pays an option as an upfront cost when signing the lease. The cost of that option can vary significantly, from 3 percent to more than 10 percent of the sale price, Orefice says.

This can help safeguard the funds. Two different types of rent-to-own contracts are lease-option and lease-purchase agreements. Here are the obligations and penalties associated with each type. When you sign a lease-option agreement, you pay an option fee to the homeowner so you can buy the home at the end of your lease term.

The lease will spell out what if any portion of the lease option or rent payment will go toward the purchase price. Remember, you can and should negotiate the option amount and monthly rent payments ahead of time.

In most cases, your option fee goes toward reducing the purchase price of the property. A lease-purchase agreement is very similar to a lease-option agreement. You still put a certain percentage of your rent payments toward a down payment to buy the home. Most rent-to-own contracts have a date on which you must switch from renting to buying the house.

The date is usually at least a year away, and often two to three years in the future. This time frame can be used to build your credit up enough to qualify for a mortgage. You can also concentrate on saving money in addition to the extra you pay each month if the down payment needs to exceed that amount.

A rent-to-own secures the house you want to buy by putting it in writing that the landlord has offered to sell you the house at a predetermined date in the future for a preset price. You are protected while you do what you need to do to qualify. When the time is up, if you still cannot qualify, the landlord has three options: Continue to rent to you and extend the contract for another future purchase date; offer to rent it to you at market rate or any other price and not sell it to you; or put it on the market and sell it to someone else.

Renting a home is different than buying. It is possible to rent for three years, only to discover that the house cannot pass a mortgage inspection. This can be avoided by paying to have it inspected before you even rent it to make sure when the time comes to purchase, you have a good chance of a loan approval. If you cannot purchase the house when your time is up, you typically lose all the money you have already paid toward the down payment. Many landlords also require a sizable cash payment at the front end as evidence you are serious about buying.

You will lose that as well in most cases if you do not follow through with the purchase. At any time during your rent-to-own period, your landlord could lose the house by not paying the mortgage, being sued and the house being taken as collateral or a lien being put on the house for financial obligations such as back taxes.

If this happens, you could sue the landlord in civil court for all the money you paid toward the purchase, but obviously, if he owes on liens, or stopped paying the mortgage, you will probably have a hard time collecting any judgment you win. Your interest rate, for instance, may be significantly higher than the rate traditional lenders could offer. On the other hand, the seller may be willing to finance your purchase when traditional lenders take a pass on your application.

Note that many consumer protections and government regulations that apply to mortgage companies and banks do not apply to private or owner financing.

Do what a traditional lender would to protect its investment. Because they are so happy the seller will finance them, many buyers fail to make sure the property is a fair deal.

You should also review the cautions about lease options above, because many of them also apply to owner-financed properties. Home buyers should get these amounts in writing and make sure that the entire payment is affordable.

Otherwise, you could risk losing the home and the money you put into it. A rent-to-own or lease option is a contract you can use to buy a home in the future at terms you agree to today. Here are a few common mistakes to look out for. You need to craft your purchase and rental agreements correctly and keep careful records to make sure this does not happen. An appraiser will determine the market rent.

A licensed appraiser can help you determine how much to increase the rent payment by completing a rental schedule. You should be commissioning an appraisal anyway before entering this agreement. Adding a rental schedule does not increase the cost by much. Throughout the rental term, maintain meticulous records of your rent payment history.

The agreement should also clearly state that the option fee will be credited toward the down payment, not toward reducing the price of the home. If that clause is included, be very, very careful about making your payment on time and proving you did. For example, some include clauses allowing sellers to cancel the deal and keep all of your option money and rental credit for being late with a single payment.

Again, if you cannot keep up this maintenance, you could end up forfeiting your money to the seller. Otherwise, the would-be homeowners moved out, losing their money, or ended up in foreclosure with mortgages they could not afford or homes that were worth less than they paid.

Potential buyers should also be wary of scams. Before negotiating a rent-to-own deal, find out who owns the home through a title search or through tax records at the local courthouse. And make sure you see the condition of the home for yourself before agreeing to maintenance — especially if your purchase option depends on maintaining the home.

The rent-to-own process creates a lot more risk to the buyer than traditional transactions. Hire a real estate attorney to work on your behalf. The seller is likely to have someone clever doing the same thing, and ignorance can be very costly to you — both upfront and later, at the end of the lease agreement.

Your attorney can review your agreement with the seller and identify clauses that could unfairly cancel your option or your right to purchase the home. It will also prevent the seller from acquiring additional mortgages against the property without your knowledge. With all the pitfalls of lease options, and the high failure rate of rent-to-own homes, why would anyone go through this?