Rent-to-Own: A Creative Way to Get Into a Million-Dollar Home

When does it make sense to rent-to-own a million-dollar home?

Rent-to-own homes are not for everyone. This method of buying a home can be more complicated than a straightforward home purchase, and it’s not a widely used technique.

However, for certain buyers, renting a home before buying it is a method that can solve problems. Whether you’re struggling with a hot housing market or have concerns about your credit score, rent-to-own homes could be your ticket to homeownership. Here are some scenarios where it makes sense to pursue a rent-to-own home:

When starter homes cost a million dollars where you live

Red-hot market prices make it tough to get into your first home when the price of entry is a million bucks. If you live in a high-cost-of-living area, you’re familiar with home prices in the millions. About 242 cities across the country now have starter homes valued at $1 million or more. California leads the way, followed by New York and New Jersey, with the three states accounting for the largest number of cities where even entry-level homes have reached the $1 million mark.

Big list prices mean big down payments, and it can take a while to save up that sort of cash. For example, if you want to put 20% down on a million-dollar house, you’ll need to bank $200,000 first, plus $40,000 to cover closing costs, which are typically about 4% of the price of the home. Depending on your salary and other expenses, that could take a long time to save up.

By using rent-to-own for these million-dollar properties, you open up a new path to homeownership, giving yourself more time to save up a down payment.

»Learn more: With starter homes hitting $1 million in dozens of cities, it’s more important than ever to know what you can really afford. Our Home Affordability Calculator makes it easy to see where you stand and plan your next move. Get a clear picture of your budget before you start house hunting.

When you don’t have a credit history in the U.S.

Your credit history is important to mortgage lenders. They don’t hand out home loans to just anyone. They need to be sure that you’re going to pay back what you borrow, and that’s especially true when you’re talking million-dollar mortgages, known in the industry as jumbo home loans.

If you don’t have a strong credit history in the U.S., whether you’re coming from another country or you simply haven’t built a history here yet, it can be tough to get a home loan.

While lenders may be able to use manual underwriting to vet you for a loan, you’ll still need, at the very least, 10% for a down payment ($100,000 on a million-dollar home) and 12 months of mortgage payments in reserve ($30,000 to $40,000 cash).

But with a rent-to-own home, you can use the “renting” period to also build up your credit score, proving to mortgage lenders that you’re a safe bet for that eventual home loan. Plus, the better your score, the more likely you are to win a lower interest rate on your mortgage when it’s time.

When you’ve found your dream house, and those are the terms

Of course, you might have a credit score that’s just fine, but the house you’ve fallen in love with comes with rent-to-own strings attached. If so, consider the offer. 

Many sellers have found that structuring their home sale as a rent-to-own can be a win-win situation for all parties involved. It gives them guaranteed income in the form of rent. And if you intend to purchase the home, you’re more likely than other renters to take very good care of the property, an ideal tenant for a homeowner.

Rent-to-own brings a lot of perks and flexibility to the potential buyer, too. If you lock in a great price when you sign the rent-to-own agreement, and the home appreciates in value, you could walk into your new mortgage with instant equity when it comes time to purchase.

If the million-dollar home you’re considering is a rent-to-own, it’s a good idea to look into its potential and see if the overall deal could work out in your favor.

When you want to take a home for a test drive

Finally, the ability to rent-to-own million-dollar homes opens the door for testing out not only the home, but also the schools, the community, and even your commute.

Sometimes, it’s hard to know whether someplace can really feel like home until you’ve lived there. Plus, you don’t want to get six months into a mortgage and find out the neighborhood isn’t meeting your needs, or the drive to work is way longer than you had expected.

With rent-to-own, you’re not locked into a mortgage and forced to try to sell if you decide the home and its location are not a good fit. Selling in the first couple of years of a home loan might mean you lose money, since you’ve only been paying on the interest, and you have closing costs and other fees to factor in.

Rent-to-own lets you take the home for a test drive, giving you added confidence that you are making the right decision when you do decide to buy.

How does rent-to-own work on a million-dollar home?

If a rent-to-own million-dollar house sounds like a good solution for you, you’ll need to know how it works. Fortunately, the rent-to-own process is basically the same regardless of the home price.

Note that rent-to-own agreements may go by other names where you live, such as “lease option” or “lease with the option to purchase.”

Work with an agent

First of all, it’s a good idea to work with an agent for these deals. They’ve got the experience, not to mention the industry connections, to help you land the right agreement.

Most importantly, your agent has your back. They have a fiduciary responsibility to look out for your best interests and the know-how to help you avoid signing a contract that doesn’t benefit you at all.

Agents also have unique access to the multiple listing service (MLS) and they can tap their own network to help you find these rent-to-own million-dollar homes. And if you don’t live in an expensive area, an agent might actually be the only route to finding these types of homes.

Rick Fuller, a Contra Costa County, California, agent who works with 74% more single-family homes than the average agent there, says an agent is indispensable in rent-to-own or lease-option situations.

“Knowing the market value and where the market is going may be very helpful in establishing a lease option,” Fuller says.

Your agent can help you identify a rent-to-own situation in an up-and-coming neighborhood where home prices are poised to explode. But they can also help you steer clear of declining areas, where you might be locked into an overly high price in a couple of years compared to market value.

“You want to make sure that you don’t get into a lease option on a property and pre-define the price and then find out two years, three years, or five years later that the property is worth less than what your option agreement is,” Fuller says.

If home prices are a million dollars now, but $800,000 down the road, you’ve lost out on your option money. You’ve also locked in a bad price and wasted time on a house in a neighborhood you might not want to be in later.

Put down a deposit

Once you and your agent have landed on the right home, you’ll likely need to put down a deposit to lock it in. If you decide to buy the house later, this will be rolled into your down payment.

You’ll probably also be required to pay what’s known as a rent premium, or option money. This is an additional amount of money included in your rent payment that is set aside to be used toward your eventual down payment. If you don’t decide to buy, in some agreements, the seller pockets this cash instead.

Read the fine print

Typically, you’ll agree on the purchase price in advance when you sign the contract.

“The best way to draft a lease option for the tenant is to define a price. The owner agrees to that price,” and then both tenant and owner should factor in market appreciation as they settle on the price, Fuller says. 

When you’re ready to exercise the option to buy, you’ve already got money set aside for the down payment or closing costs, and if the property appreciates in value beyond what you offered to pay for it, you automatically have equity in the property.

“If the property has appreciated like what we’ve seen in recent years in the San Francisco Bay Area and Sacramento County, then you automatically have equity at the time you close escrow,” says Fuller.

That’s because you already agreed upon a price at the time of signing the lease, “which may have been two, three, four, even five years prior,” he says. Homes in hot markets can appreciate a lot in that amount of time.

This rent-to-own setup can work out well for sellers, too. They get rental income while the tenant is living in the home, plus a potential buyer already lined up down the road. Depending on the agreement, the tenant may also be responsible for some of the home’s maintenance and repairs, which can take some of that work and expense off the seller’s plate. Agreeing on a purchase price upfront also gives sellers a better idea of what they could make from the sale, especially if the price accounts for how much the home may appreciate over time.

That said, find out before you sign whether you’ll be responsible for the home upkeep costs while you’re renting there. It’s quite common for the renters in rent-to-own situations to take on most of the maintenance, unlike in typical rental agreements. Since you may become the eventual owner anyway, it’s to your benefit to make sure repairs and maintenance are done well and on time.

Go over your contract with a fine-toothed comb so you know exactly what’s expected of you and what will happen if things do (or don’t) go your way when it comes time to purchase.

What to consider financially when rent-to-owning a million-dollar home

Now that you know how rent-to-own works for a million-dollar home, it’s time to look at the numbers you’ll need to make it work. The rental period can give you time to save, improve your credit, and get ready for a mortgage, but you’ll still need to qualify for a sizable loan when it’s time to buy. Here’s what to consider financially before signing a rent-to-own agreement.

Income and credit requirements for a million-dollar home

The income you’ll need depends on your down payment, existing debts, interest rate, and the lender’s requirements. As a rough example, if you buy a $1 million home with 20% down, you’d need an $800,000 mortgage. At a 6.5% rate on a 30-year loan, the principal and interest would be about $5,057 a month.

Once you add property taxes (1.25% annual rate), homeowners insurance ($2,500 annually), and any other debts, you could need roughly $175,000 or more in annual gross income to keep your debt-to-income ratio around 43%, assuming you have little or no other debt. Your actual requirement could be higher depending on the lender and your financial profile.

The rent-to-own period can give you time to get your finances ready for a mortgage. If your credit needs work, focus on paying bills on time, paying down credit card balances, avoiding unnecessary new debt, and checking your credit reports for errors. Building your savings during this period can help, too, since jumbo lenders may want you to have several months of mortgage payments in reserve.

Down payments, option fees, and rent credits

Rent-to-own agreements may require an upfront option fee, which gives you the right to buy the home later. You may also pay a rent premium above the normal market rent, with the agreement stating that some or all of that extra amount will go toward your eventual purchase. But don’t assume these payments automatically become part of your down payment. The contract needs to clearly spell out how they’ll be credited.

Fannie Mae allows rent credits from a rent-to-own agreement to be applied toward the down payment or minimum borrower contribution. The credit is generally based on the difference between the home’s market rent and the rent actually paid. Rent credits can cover more than 12 months, provided you meet the requirements. You need documentation showing your rental payments, such as bank statements, along with the required terms in the rental-purchase agreement.

Also remember that your rent credits may not cover all your expenses when it’s time to buy. You could still have closing costs, lender fees, appraisal costs, title fees, prepaid taxes and insurance, and other upfront expenses. For a million-dollar home, those costs can add up quickly, so build them into your savings goal rather than counting entirely on your rent credits.

»Learn more: Want to know what you’d actually pay each month for your dream home? Use our Mortgage Payment Calculator to crunch the numbers before you start house hunting.

What are the common rent-to-own-contract pitfalls to watch for?

The fine print can make a big difference in a rent-to-own deal, so don’t stop at understanding whether you have a lease option or lease purchase agreement. There may be other terms buried in the contract that could cost you money or make it harder to buy the home later. Here are a few common pitfalls to look out for before signing.

Being aware of these red flags can save you thousands and keep your path to homeownership on track.

Work With a Top Agent to Find a Rent-to-Own Home

When considering a rent-to-own home, working with a real estate agent experienced in these types of deals can help you navigate the process and find a great deal.

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Always worth a look

As you weigh the pros and cons of a rent-to-own million-dollar home, remember that there is no one true path to homeownership. The important thing to do is to take the long view and make informed decisions.

That’s where your agent is really going to come in clutch: helping you understand the market you’re looking to buy in, the deal that you’re considering, and the longer-term ramifications of your potential investment.

With the right agent behind you, you may find an unconventional way to get into the home of your dreams at a price you can actually afford.

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