Is a Rent-to-Own Property Right for You?

Here's what you need to know about entering a rent-to-own program.

In today's real estate market, a lot of buyers are struggling to buy homes for one big reason -- there's such limited inventory that property values are being driven upward. As such, you may not be able to afford to buy a home right now, despite mortgage rates sitting near record lows.

If you really want to purchase a home but can't swing one immediately, you may be interested in a rent-to-own program. Here, we'll discuss the pros and cons.

How rent-to-own works

With a rent-to-own agreement, you sign a contract to rent a home that you then have the right to buy or are obligated to buy after a certain period of time (usually, up to five years, though that time frame may be shorter). Meanwhile, your landlord -- who's also your seller -- will help you sock away funds for that home by allocating a portion of your monthly rent payments toward a down payment on that property.

The upside of rent-to-own programs

A rent-to-own program could make it possible for you to buy a home in a few years if you can't swing one right now, whether it's because you don't have enough money for a down payment or your credit score isn't high enough for you to qualify for a mortgage. These programs are also a type of forced savings, as a portion of your rent is set aside to eventually cover your home purchase.

Also, some rent-to-own agreements don't force you to go through with the purchase at hand, so with this setup, you get flexibility. If you decide after renting your home for a few years that you don't want to buy it, you can back out. That said, some rent-to-own contracts do compel you to go through with your purchase or otherwise face penalties. So you'll need to review your agreement carefully and make sure you understand what terms you're signing up for.

The downside of rent-to-own programs

With a rent-to-own arrangement, the amount of monthly rent you pay will generally be higher than what you'd pay for a comparably sized home to rent. Of course, that extra money is going toward your home's down payment, so you're not just throwing it away. But if you want more flexibility with your finances, you may be better off just renting an inexpensive home while you save for a down payment, work on boosting your credit, or both.

Also, if you're unable to qualify for a mortgage once your rental term is up, you won't be able to buy your home even if you want to go through with the deal. And at that point, you could risk a costly penalty, even if you tried your best to keep up your end of the bargain.

Finally, one thing you should know is that with a rent-to-own agreement, you'll need to commit to a certain sale price when you enter into your arrangement. But if home values fall over the next few years, you could end up paying more than necessary.

Right now, as mentioned, home prices are really inflated so that if you enter a rent-to-own contract to rent for three years and buy a home for $300,000 once that term is up, you'll be locked into that price. But a home that could sell for $300,000 in today's market may only be worth $260,000 three years from now, once the housing market cools off. So that's a risk you'll be taking on.

While a rent-to-own agreement could be a wise choice for you, in today's market, it may not make sense -- and it may also be very difficult to come by. With a rent-to-own agreement, sellers take on some degree of risk that you don't end up buying the home. And since it's a seller's market right now, that's a risk they generally don't have to take. But if you do find a seller who's game, be sure to weigh your options carefully before signing one of these contracts.