Austin Property Management Blog

Planning to buy a house? One of the enduring questions about home ownership is whether to go for the rent-to-own or the mortgage option. The ongoing discourse on rent-to-own vs mortgage is primarily because both options have their fair share of advantages and disadvantages. The challenge is knowing which one best fits your situation.

To help you on this journey, we’ll provide you with a comprehensive overview of rent-to-own agreements and mortgages. We’ll highlight key features, pros and cons, and the primary differences between the two to help you decide which home ownership route to opt for.

3 Key Takeaways

• Rent-to-own agreements offer a gradual path towards homeownership without the huge financial pressure upfront.
• Home buyers can enjoy immediate ownership and its benefits when purchasing with a mortgage.
• The choice between RTO and mortgage depends on your long-term goals and financial situation.

What is a Rent-to-Own Agreement?

Rent-to-own is an alternative option to achieve home ownership. Here, the tenant enters an agreement with the homeowner for a rent-to-own contract. They pay rent to stay in the property, but with a portion of that payment going towards the goal of purchasing it at the end of the lease. So, how does this work?

Let’s say that you find a house that you really love, but you don’t have the funds to purchase it. Entering an RTO agreement with the house owner allows you to (1) rent to live in the property and (2) purchase the house with the funds you accumulated through your monthly rent payments. 

Coming from our experience as an Austin property management company, we can attest that there is a growing interest among tenants in rent-to-own (RTO) properties. Tenants looking for a place to rent are also inquiring about RTO properties, in hopes of leveraging their monthly rent payments towards something bigger. In fact, recent research even reports a 7.32% compound annual growth rate for the US rent-to-own market in coming years.

But what exactly makes RTO attractive to aspiring homeowners? Here’s why:

• Rent-to-own agreements allow people to slowly work towards their goal of becoming homeowners. You don’t have to put down a significant down payment or worry about amassing debt because of loan interests.
• RTO serves as an alternative route for people who cannot meet traditional home loan requirements.
• You don’t have to worry about a bidding war against other buyers.
• You have the opportunity to experience the property long-term before committing to buying it. And, depending on the RTO agreement, you can opt out if you decide that the place is not for you.
• RTO allows you to work on improving your credit score to secure a loan by the end of your lease.

But if rent-to-own is so enticing, why isn’t everyone doing it? Well, this is because RTO still has its drawbacks that are making some people have second thoughts. Here are some of them: 

• Since a portion of your monthly rent goes toward buying the property, your rent is going to be significantly larger than usual. You also risk losing this fund if you decide not to push through with the purchase.
• RTO is a long-term commitment. Leases for rent-to-own properties typically extends to 2 to 3 years.
• If you have a lease-purchase RTO agreement, you are legally obligated to purchase the property at the end of your lease, even if you cannot or no longer want to.
• The appraised value of the property you want to buy may diminish significantly over time.

How Rent-to-Own Agreements Work

Rent-to-own agreements typically include two parts: a lease agreement and an option to purchase. They include several key components that may vary slightly based on the individual contract.

1. An Option Fee – This is a non-refundable upfront fee paid by the tenant to the property owner that demonstrated their serious interest in the property. Option fees range from 1% to 5% of the purchase price and secures the tenant's right to buy the property later and may go toward the purchase price if they proceed.
2. Lease Terms and Rent – These spell out how long you will rent before you can, or have to, buy the property. In addition, monthly rent is usually higher than market. In these agreements, a portion (called rent credit) is applied toward the purchase price.
3. Purchase Price – A purchase agreement sets an agreed upon market value of the property at the time of purchase. Thus, locking in the price early – which can be beneficial for tenants in a rising market.
4. Option vs. Obligation – This is critical! A lease-option means the tenant has the choice to buy at the end of the lease. In contrast, a lease-purchase means you must buy the home at the end of the term.
5. Maintenance and Repairs – Often with a RTO agreement, tenants take on more responsibility than a typical renter, reflecting the assumption that they’ll eventually own the home.
6. Financing Responsibility – RTO offer a great way to save up or take time to work on your credit. But when it comes time to buy, tenants must secure their own mortgage or financing approval.
7. Default Terms - What happens if you miss a payment, back out of buying, or break the lease? Most option fees and rent credits are non-refundable if the tenant doesn’t purchase. There may also be hefty financial legal or financial consequences for breaking the contract.

What Is a Traditional Mortgage?

While RTO agreements are growing in popularity, we can say that mortgages are still the most common option for people looking to buy a property. Mortgage, in simple terms, refers to the different types of loans that you can apply for to buy a house. It involves borrowing a lump sum of money from a bank or a lender in order to pay for a property upfront.

Here’s an example scenario. You want to buy a house priced at $450,000. In order to buy this, you can apply for a loan where you only have to pay for a portion of the price (around 10%-20%) and the bank will cover the rest. Now, your mortgage payments (with interest) are billed on a monthly basis and are paid typically over a 15 or 30-year long term. Mortgages allow you to completely purchase a property and put it under your name, even if you’re still working on paying off your loan.

On top of this, mortgage loans have several more advantages, including:

• You can still enjoy low down payments with mortgages. For first-time home buyers, the required down payment can go as low as 3.5% to 8%.
• Interest rates vary from bank to bank or lender to lender. Considering this, you have the opportunity to find the most competitive rate for your home loan.
• Lenders generally offer some flexibility on their lending options to accommodate various financial situations.

However, applying for mortgage loans can be stressful. Here’s why:

• Since mortgage loans involve large sums, home buyers need to go through an extensive application process with stricter requirements, credit checks, and rigid income verification.
• Mortgage applications take a long time to process, putting you at risk of losing the property you have your eyes on.
• Applicants need to have a high credit score and strong financials to be approved.
• The bank or lending company can foreclose your property if you fail to keep up with your mortgage payments.

Key Differences Between Rent-to-Own and Mortgages

Now, what exactly makes rent-to-own and mortgages different from each other? The first main difference is how you become a homeowner. With a mortgage, you become the property owner once you complete the purchase, since you’re paying for the property upfront. On the other hand, you work your way towards homeownership little by little in rent-to-own lease agreements. You only get the option to purchase the property once your lease ends.

In terms of down payment, rent-to-own contracts generally ask for minimal down payment. Typically, in the form of a rental deposit. In contrast, mortgages require a significant down payment for you to be approved for the loan. Aside from that, there’s also a difference in terms of the monthly payments. RTO has relatively higher monthly payments since a part of it goes toward your fund to buy the property later on. In
comparison, mortgage payments offer more ownership benefits since these proceeds go to your property taxes, interest, principal, and insurance.

Which Option Makes Sense for Your Situation?

With all of these pros and cons in mind, the question still stands - should you go for rent-to-own or apply for a mortgage loan? To answer this simply, it depends on your financial situation and personal circumstances.

Let’s start with the rent-to-own route. First, RTO is a good alternative for people who cannot secure a loan, whether they have low credit scores or simply cannot meet eligibility criteria. Similarly, you can opt for RTO if you’re struggling to save up for a full upfront down payment. Aside from these, this option is best for individuals who have already decided that they are going to settle down in the area.

But what about mortgages? Generally, applying for a home loan is a good option for people with good credit scores and those who have the funds for a down payment. Other than that, you must have an acceptable debt-to-income ratio (if you have any) in order to be approved for the loan.

Make Moves Toward Home Ownership

The path towards homeownership can feel overwhelming. With the option between rent-to-own vs mortgage, you have the opportunity to find the one best fitting to your situation. In rent-to-own agreements, you can pay a monthly rent (albeit higher) with a portion of it going towards purchasing the property at the end of the lease. The advantage of this setup is that you don’t have to worry about down payment. The more traditional path would be mortgages, where you ask the bank or a lending company for a loan to be able to pay for the property upfront.

But, if you're new to the area or uncertain about buying in general, traditional renting offers a flexible and often preferred housing option for many. We at Stone Oak Property Management have more than two decades of industry experience helping match tenants with their dream rental property. Looking in the Austin area? We can help! Check out the latest property listings or give us a call today to connect with a dedicated leasing agent.