Is rent-to-own a scam? (© PhotoAlto/Eric Audras/Getty Images)

The want ads practically shout from the pages of Craigslist: "Own a home for $699 a month," or "Rent to own! No background checks. No credit checks. No questions."

If you’re struggling either to sell a house or to qualify for a home mortgage, a lease-option or rent-to-own deal may sound tempting. In theory, both sides win. The seller gets a series of cash payments and the buyer immediately moves into his dream home, while gaining time to improve his credit score.

But before you consider a lease-option or rent-to-own agreement, make sure you understand the possible pitfalls. One misstep and your dream of homeownership could go up in smoke.

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"It's very risky for the occupant to go into rent-to-own," said Donald Haurin, an economics professor at Ohio State University in Columbus. "All you have to do is violate some part of the contract — a late payment or some kind of maintenance obligation — and the owner can say the contract is violated. If there's some money that's been set aside for future equity, that can be lost."

Why rent-to-own is booming now
The declining housing market and tougher lending standards are putting pressure on sellers to help buyers. One tactic is a lease-purchase agreement, under which the buyer rents for a set period of time before exercising an option to purchase the home. It's especially attractive for sellers in a down market because it locks in a price that otherwise could continue to fall.

Discuss:  Would you consider a rent-to-own agreement, or do you think it's a rip-off?

"A number of sellers, particularly developers, are turning to that," said John McIlwain, senior fellow for housing at the Urban Land Institute. "It's definitely growing."

Whether called rent-to-own, lease-option or lease-purchase, all these programs are similar in theory: The renter is buying the right to purchase the house later for a given price. If, at the end of the agreement period, the renter doesn't qualify for a loan or simply doesn't want to buy, the landlord keeps the money.

Typically, renters pay either a large upfront fee, called an option fee, of 1% to 3% of the home's purchase price, or finance the option fee by increasing the monthly rent. Usually some or all of the option fee is credited as a down payment on the house.

During the rental period, the landlord still owns the home and is legally responsible for it, but the renters often maintain the property as their own.

Families get a jump on homeownership
A lease-purchase agreement let David and Andrea Colby of Athens, N.Y., move their family of four into a brand-new house without forking over any cash. All 12 months of rent payments were credited to their down payment when they closed on the house last year.

"It was a good way for us to transition into it, to make sure we liked the home," David Colby said. "We had an extremely positive experience."

Among the benefits of rent-to-own:

  • The buyer can evaluate a neighborhood and property without making a 30-year commitment.
  • Families can immediately enroll children in a desirable school district.
  • The buyer can move right in despite credit problems, inability to document income or lack of financing.
  • The seller gets a tenant with a vested interest in keeping up the property.
  • The seller receives rental income to cover the mortgage, helpful in a slow real-estate market.
  • The seller taps a broader market of potential buyers, instead of being limited to those with excellent credit and cash for a down payment.
  • If a sale goes through, the seller may save on real-estate agent commissions.

A rent-to-own horror story
Before you get carried away, here’s a cautionary tale.

Julie Parker agreed to a rent-to-own deal because her Sylacauga, Ala., home had been on the market almost a year, and her family needed to move to Kansas City, Mo., for her husband to begin a master's program.

The woman who wanted the house couldn't document her income because she was largely paid in cash, Parker said. A mortgage broker said that if the tenant made on-time rent payments for 12 months and got rid of some debt, she could get a loan.

Before the year was up, the renter defaulted on the agreement and the house fell into disrepair. Parker gave birth to her third child, so the family didn't have the time or money to travel to Alabama to restore the house to salable condition.

"We couldn't pay the medical bills, and the mortgage and the house ended up going into foreclosure," she said.

Now, the Parkers' once-stellar credit is a mess. They aren't considering job opportunities outside of Kansas City because they couldn't qualify for a mortgage if they sold their current home and moved.