We currently rent a house. Our credit is ok, but we're working on it (paying things off, disputing things, etc). We are first time buyers. We have a good relationship with the owners. We are thinking about buying the house. Which way would be better for us to approach, going through a bank to get a mortgage or doing a rent to own setup? What are the advantages/disadvantages of both? If we rent to own are we building equity? If we rent to own, can we escape if we have to (read: can't pay anymore). How does rent to own affect (or not) our credit?
It depends on the deal: and you didn't give any details. That said, there are some things that stand out regardless, and some more specific answers to your questions.
First, Mortgage rates (at the bank) are absurdly low right now. Like 4%-5%; less than 4% for excellent credit. You say your credit is ok, so unless your landlord is willing to do a deal where they get no benefit (beyond the price of the house), the bank is the way to go. If you don't have much for a down payment, go with an FHA loan, where you need only 3.5% down.
Second, there is another option in between bank mortgage and rent-to-own. And that is that where your landlord "carries the note". Basically, there is a mortgage, and it works like a bank mortgage, but instead of the bank owning the mortgage, your landlord does. Now, in terms of them carrying all of it, this isn't really helpful. Who wants to make 3-4% interest?
But, there is an interesting opportunity here. With your ok credit, you can probably get pretty close to 4% interest at the bank IF the loan is for 80% LTV (loan to value; that is, 20% equity). At 80% LTV you also won't have PMI, so between the two that loan will be very cheap. Then, your accommodating landlord can "carry" the rest at, say, 6-7% interest, junior to the bank mortgage (meaning if you default, the bank gets first dibs on the value of the house).
Under that scenario, your over all interest payment is very reasonable, and you wouldn't have to put any money down.
Now for your other questions:
Not usually. Like the other posters said, rent-to-own is whatever both parties agree on. But objectively, most rent-to-own agreements, whether for a TV or a house, are set up to screw the buyer. Sorry to be blunt, and I'm not saying your landlord would do that, this is just generally how it is with rent to own. You don't own it till you make the last payment, and if you miss a payment they repo the property. There is no recourse because, hey, it was a rental agreement! Of course the agreements vary, and people who offer rent to own aren't necessarily bad people, but it's like one of those payday loan places: They provide a valid service but no one with other options uses them.
Usually, sure! Think about what you're saying: "Here's the house back, and all that money I paid you? Keep it!" It's a great deal if you're on the selling side.
It all depends on how it's structured. But really, it comes down to are they going to do reporting to the credit bureaus? In a rent-to-own agreement between individuals, the answer is no. (individuals can't report to a credit bureau. it's kind of a big deal to be set up to be able to do that)
'Rent to own' is not a precise, single agreement. It can be whatever the seller and you agree to. At its simplest, you might pay a premium on your rent to fix the price, giving you the option to buy during a particular period at that price. It can be a much higher premium where you are paying the landlord a full downpayment, and once you hit 20%, you agree to finance the balance either with a bank loan or through the seller.
Buying a home you will live in is a personal decision. With no numbers offered, it's not like we can tell you if it's a wise purchase.
We can, however, talk about the qualitative tradeoffs of renting vs owning.
The major drawback which you won't hear enough about is risk. You will be putting a very large portion of your net worth in what is effectively a single asset. This is somewhat risky. What happens if the regional economy takes a hit, and you get laid off? Chances are you won't be the only one, and the value of your house will take a hit at the same time, a double-whammy. If you need to sell and move away for a job in another town, you will be taking a financial hit - that is, if you can sell and still cover your mortgage. You will definitely not be able to walk away and find a new cheap apartment to scrimp on expenses for a little while. Buying a house is putting down roots.
On the other hand, you will be free from the opposite risk: rising rents. Once you've purchased the house, and as long as you're living in it, you don't ever need to worry about a local economic boom and a bunch of people moving into town and making more money than you, pushing up rents. (The San Francisco Bay Area is an example of where that has happened. Gentrification has its malcontents.)
Most of the rest is a numbers game. Don't get fooled into thinking that you're "throwing away" money on renting - if you really want to, you can save money yourself, and invest a sum approximately equal to your down payment in the stock market, in some diversified mutual funds, and you will earn returns on that at a rate similar to what you would get by building equity in your home. (You won't earn outsized housing-bubble-of-2007 returns, but you shouldn't expect those in the housing market of today anyway.)
Also, if you own, you have broad discretion over what you can do with the property. But you have to take care of the maintenance and stuff too.