The housing market is red hot. Home prices are soaring, and rents are not far behind. So what to do if you are in need of an affordable place to live? Especially if you have less than stellar credit or you don’t have the cash to outbid the competition?
One intriguing — but polarizing — option is the rent-to-own model.
Over the last several years, a group of startups has been reinvigorating an old path to homeownership: the the lease-option agreement, sometimes called rent-to-own or contract buying. In the simplest terms, this type of agreement will let you rent a house and then eventually buy it from your landlord.
“A portion of your monthly payment is treated as rent, and then a portion of your monthly payment is treated as continued savings or a down payment toward the home,” says Michelle Boyd, the director of the Housing Lab at the Terner Center for Housing Innovation at the University of California, Berkeley.
Proponents say the model makes homeownership possible for those who wouldn’t otherwise be able to afford it. The time spent renting is intended to give the future buyer a chance to work toward qualifying for a mortgage by boosting savings, improving their credit score and paying down debt.
Detractors, on the other hand, say the model makes hopeful homeowners beholden to corporate landlords that often charge above-market rent. Critically, there’s also no guarantee that you’ll be able to qualify for a mortgage at the end of your lease.
The history of rent-to-own homes
History is on the side of the detractors, but the people building and investing in these startups believe they are expanding access to homeownership and providing a viable path to people who would otherwise be shut out of the market.
“I think that people are naturally very skeptical of the rent-to-own model … given what the history has been,” says Adena Hefets, CEO of Divvy Homes, a startup in this market. However, she sees companies like Divvy as taking “historically non-consumer-friendly industries and disrupting them” — which is how lots of now widely accepted financial technologies got started.
Rent-to-own contracts have been around for decades, and their previous iterations were notoriously predatory. Arrangements called land contracts “were used by people who owned property to steal wealth from people who couldn't access traditional mortgages,” Boyd says, especially people of color and others who lacked access to the mainstream financial system.
Under land contracts, tenants who missed a single payment could be evicted and would lose all the equity they’d already invested in the house. Those who managed to make every payment on time were often forced to purchase the home at an enormous markup. According to one estimate, the system of contract buying cost Black families in Chicago between $3 billion and $4 billion over the course of two decades starting in the 1950s.
As recently as 2016, the Federal Trade Commission warned of scams surrounding rent-to-own agreements and advised consumers to avoid them. “Even with legitimate rent-to-own deals, the devil is in the details," the agency wrote. “Consider saving up your money and working on repairing your credit to buy a house down the road.”
How does rent-to-own work?
Now, a handful of startups are working to revamp the rent-to-own model — and its image. In addition to Divvy, companies like ZeroDown, Landis Technologies, Home Partners of America and Verbhouse were founded around 2017 and 2018 (with the exception of Home Partners, which was founded in 2012) and are now gaining ground.
So far, these companies have avoided major controversy. After three years in business, Hefets says roughly half of Divvy customers are able to buy back their properties. A January article from the Financial Times said Home Partners reported its own conversation rate was about 20%. (Money was not able to verify this figure.) In general, these companies say they only approve renters they judge as having a path to mortgage approval.
The companies are also attracting major investments. Home Partners was recently acquired by private equity giant Blackstone for $6 billion, and venture capital investors valued Divvy at $2 billion last fall. Last summer, a group of investors including funds associated with Jay Z and the actor Will Smith invested $165 million in Landis.
For consumers, the particulars vary with each platform, but the principles are the same across the board. You’ll sign on with a company, get approved for a budget and pick out a home that’s already on the market. Then, the company will buy the home on your behalf.
Next, you’ll rent back the home for a fixed period of time, usually two or three years but potentially as many as four or five. You might have to put a small amount down to start. A portion of your rent accrues toward your down payment over the term of your lease. At the end of the lease, the idea is that you’ll be in good shape to buy the home from the company.
At that point, you’ll still need to qualify for a mortgage the traditional way — and the company cannot guarantee that you will. (You can also buy the house earlier if you qualify for a mortgage sooner.) If you can’t get a mortgage, you can either walk away with your savings or some companies will allow you to extend the term of your lease.
Who are rent-to-own homes good for?
These programs are aimed at potential homeowners who might not otherwise get approved for a mortgage because of limited savings or issues like bad credit, large amounts of student debt or variable income. Landis Technologies, for instance, is specifically aimed at low-income buyers.
Hefets says Divvy’s customers tend to earn between $50,000 and $150,000 annually and have FICO scores between 630 and 650. The largest segment of Divvy’s customers are healthcare workers, she says, followed by educators and 1099 contract workers.
Healthcare workers often have large burdens of student debt, Hefets says, while educators often struggle to put together a down payment — two challenges that make it difficult to qualify for a mortgage. Meanwhile, gig workers and the self-employed often struggle to get mortgages even if they make good money because lenders like to see consistency.
The benefits for these groups can be substantial: Rent-to-own programs provide time to build up a solid credit history in preparation for taking out a mortgage. And because savings are built into the monthly cost of rent, progress toward a down payment happens automatically.
Since renters usually lock in a purchase price as part of lease, they can end up with homes that are worth significantly more than they were when they started renting when the housing market is this hot. The programs could also allow buyers the opportunity to live in a more in-demand area than they could otherwise afford on their own.
What are the downsides of rent-to-own?
A lease-option program, even from a buzzy startup, can have downsides. There’s always a risk, Boyd says, that customers will not end up owning the property. It’s possible that in today’s wild housing market, the company won’t be able to win the house that you’ve chosen. (Though as all-cash buyers, the companies have an edge.) There’s also no guarantee that you’ll actually be approved for a mortgage at the end of your lease.
Boyd says potential rent-to-own customers should understand that using one of these programs is “not the same as buying your home.” Hefets agrees that rent-to-own programs aren’t for everyone. If you can get a mortgage the traditional way, she says, “that should be your first choice, always.”
That’s because most mortgages are backed by the federal government and subsidized. The sooner you fully own the home, the sooner you begin to build wealth and equity in a way that you couldn’t if you were renting. And with mortgage rates relatively low (at least historically), mortgages are “the cheapest debt you’re ever going to have in your life,” Hefets says.
It also bears remembering that rent-to-own programs aren’t the only option for homebuyers who need assistance. Many states and counties offer first-time homebuyer programs that can help with everything from affording a down payment and closing costs to securing competitive mortgage rates.
If you think a rent-to-own program might be a good choice for you, know that each company’s offering is a little bit different, which is why it’s so important to do your homework.
Make sure you know how large a monthly payment you can afford. Also, make sure you understand the terms of the agreement: Who will handle maintenance, repairs and improvements to the property? What happens if you miss a payment? How is the purchase price of the home calculated? Does the company have a good track record of converting renters to owners?
“As with anything related to money,” Boyd says, a rent-to-own program “may be a good situation for one customer and a bad situation for another.”