Rent to Own vs. Owner Finance

Rent to own and owner financing options are two unconventional ways to purchase a home. They are significantly different, each with its own advantages and disadvantages. Both offer solutions for people with bad credit who aren't in a situation to find a conventional mortgage. Renting to own gives you an option to test-drive the house before you buy it, while owner financing is an outright purchase -- just not through a bank.

Renting to own a home is also called a lease-purchase. Although you are renting the home, the lease agreement includes a clause that typically specifies the current sales price of the home, the amount of your rent that is applied toward that sales price each month and the amount of time you can rent before buying the home. Being a tenant gives you more time -- often two years but possibly more -- to secure conventional financing to purchase the home.

Most rent-to-own agreements require a hefty down payment; the down payment may not be 20 percent of the value as required by many mortgage companies, but it's usually higher than a standard rental security deposit. The monthly rent is typically higher for a rent-to-own arrangement than it would be with a straight rental agreement to cover the amount applied to the down payment.

With owner financing, the owner acts like a bank, offering financing to the buyers. Unlike rent-to-own options, the buyers legally own the home instead of renting with the hopes to buy in the future. This is helpful for couples who have bad credit or not enough credit to qualify for a conventional mortgage.

Owner financing typically requires a down payment, although often not as high as mortgage companies require. The owner and the buyers sign a legal mortgage agreement that specifies the term of the loan, interest rate, monthly payments and additional clauses, just like a traditional mortgage.

Both methods of financing provide a way for people with bad or no credit to move into homes immediately without waiting for mortgage approval from a bank. With rent-to-own homes, the tenants have time to save up for a down payment to the bank and to rebuild their credit before seeking financing. This option gives tenants a chance to learn about the neighborhood, schools and the house before committing to buy.

With owner financing, the buyers must be ready to purchase immediately. There's no option to end or break a lease; you own the home and have the freedom to customize it to fit your personality.

Renting to own can be dangerous for the tenants in several ways. If you fall behind on your rent and are evicted, you lose your down payment and all the rent you used to pay down on the sales price of the home. This may also happen if tenants fail to qualify for mortgage financing before the end of the lease term; under many contracts, the landlord can refuse to renegotiate your lease, forcing you to move out without recouping the money you paid toward the home.

With owner financing, the owner/lender can't force you to leave a house he's financing unless he starts foreclosure proceedings if you fail to pay your mortgage payment.

When you are renting to own, you're counting on your landlord to pay his mortgage on the property. If he fails to do so and his bank forecloses on the home, you must move out at the end of your lease. It's unlikely the landlord can pay you back your down payment and additional rent payments.

With owner financing, the owner can't finance the home unless he doesn't owe money on it, so there's no chance you can lose the house through a foreclosure on the owner. To ensure there's no existing mortgage on the property, finalize your owner-financed mortgage using a real estate attorney.

The attorney can conduct lien and title searches to make sure there is no additional claim to the property and file the proper paperwork with the county to list you as the legal owner. If the seller attempts to use the home as collateral on loans later, the bank's research reflects you as the owner, preventing him from taking out a loan against your house.

As the legal owner of an owner-financed home, you are responsible for upkeep and taxes, unlike a rent-to-own situation, where the landlord handles both those items. On both rent-to-own and owner financing options, expect to pay more for the house, either through a higher sales price or higher interest rate.