A Rent-to-Own Car: How It Works

If you have bad credit but need a car, you have one of three choices: borrow a car from a friend or family member, buy a car using a subprime car loan or buy a car in a rent-to-own scheme.

Relying on family or friends can be fine – until it isn’t. And if you are stuck using a subprime loan, you can expect to pay about 12% to 12.5% interest on a car loan – or even more, depending on your credit score. Contrast that with borrowers with good credit, who can get a loan at 5% or less. That leaves rent-to-own, which may look like a better option when considering these high interest rates. However, you need to consider all aspects of the deal in order to decide whether it is, in fact, the better choice for you.

Good Credit vs. Bad Credit

First, let’s compare the terms for a $10,000 car loan when you have good credit versus when your credit is bad.The monthly payment on a $10,000 car loan for three years at 5% for someone with good credit would be $299.71. That same loan for a subprime borrower at 12% would be $332.14 per month.

In this scenario the subprime borrower will pay a total of $1,167.48 more in interest for the same car (an additional $32.43 per month for 36 months) than a person with good credit. If that monthly obligation is too high for you, rent-to-own may be worth consideration, but it might not save you any money. (See also: Bad Auto Loans – The Other Subprime Disaster.)

How Rent-to-Own Works

One benefit of rent-to-own cars is that they're easier to get. The rent-to-own market allows people to get a car without requiring a credit check. This makes it much easier to qualify for a purchase if your credit is less than stellar – even a subprime loan requires a credit check. All you need to show is proof of identity, residence and income.

Payments are made on a weekly rather than monthly basis and usually range from $75 to $100 per week, depending on the base price of the car. There are no interest costs that can build up, but there usually is a $25 fee for late payments. Generally, you make payments directly to the car dealership, but if you purchase from a large chain, payments may be managed using a national bill-paying service. It's something like leasing a car except that a portion of the payment goes toward purchasing it at the end of the lease period.

Car dealers that offer rent-to-own options usually cater to the subprime market and push high-mileage, mechanically sound cars that could otherwise be sold at auction for $5,000 to $6,000. They sell these cars for at least a 100% mark-up – usually double the auction price – and base the rental price on this mark-up. So if a rent-to-own dealer offers you a price of $10,000, it is likely they bought the car for $5,000 at auction.

You’ll be required to make a down payment and weekly payments that add up to the $10,000 price. While the dealer won’t charge you interest, he makes his money on the 100% mark-up on his original cost for the car, plus any rental fees he adds during the rental period.

Rent-to-Own vs. Subprime Loan

Here’s an example of the costs of rent-to-own. On that $10,000 car, the dealer might expect a $2,000 down payment and then payments of $75 a week for 156 weeks (three years). In this scenario, you would pay $11,700 (156 x $75) in weekly payments, and the total cost, including the $2,000 down payment, would be $13,700. For the sake of comparison, if you figure the payments on a monthly basis, it would be $325 [($75 x 52) divided by 12].

Had you bought that same car for $10,000 using a subprime loan, your monthly payments would be higher, but only slightly: $332.14. However, the total out-of-pocket payments for the subprime loan would be $1,742.96 less​ than for the rent-to-own program: $11,957.04 (36 payments at $332.14) vs. $13,700.

When considering rent-to-own versus a subprime auto loan, you should do a similar calculation to be sure the rent-to-own option makes sense for you. In this example, you'd be stuck with a down payment and an only slightly lower monthly cost. A subprime loan might be the better choice.

Pros and Cons

Here are the pros of getting a car through a rent-to-own program:

• Ownership – At the end of the rental term you own the vehicle. But check to be sure whether you first need to make an additional payment before you own the car.

• No credit checks – A credit check is not required, but it is a good idea to ask the dealer to report your payment history so you can build a better credit history in the future (as long as you make on-time payments).

And the cons:

• Over-priced cars – Rent-to-own cars are usually marked up more than other used cars because that’s how the dealer makes a profit. (There is no interest on these cars, and he’s not profiting from the sale of a subprime loan.)

• Frequent payments – You pay back the loan weekly, far more often than the average car buyer (who pays monthly). Having to make 52 payments a year can make it easier to miss a payment and incur a late fee.

• No warranty – Typically there is no warranty on a rent-to-own contract, so if the car breaks down the week after you sign the contract, it’s your problem to fix.

Payment Distribution

The amount of your weekly payment that goes toward buying out the car at the end of the rental period will differ. Be sure you know how much of that weekly payment will go toward ownership of the car and how much toward rental. Also, more money may be due at the end of the rental term, so be sure you have in writing what that amount will be, should you decide you want to buy the car at that time.

Early Termination

Review your contract regarding terms for early termination. This can be critical if you find that the car needs a lot of repairs. You may decide a few months or a year or two down the road that you don’t want to own the car and would like to end the rental. You likely will lose your down payment and any money paid toward the purchase of the car, but at least you’re not stuck with a subprime loan on a car that is no longer working.

The Bottom Line

A rent-to-own car deal may not save you money, but it may be a viable option, depending on your weekly budget. You will also likely find it easier to get out of a rental contract than a subprime loan.