Are you eager to buy a home but need some time to build up your savings and credit score? Eager to sell your home but not receiving any offers from qualified buyers?
A rent-to-own agreement – achieved by way of a lease option contract – can be the ticket to accomplishing your goals. Check out what’s involved and some of the pros and cons to see if this type of agreement might be right for you.
What Is Rent-To-Own?
Though the term “rent-to-own” might seem pretty self-explanatory at first glance, there’s a little more to it than you might expect.
Essentially, a rent-to-own agreement is an agreement between a tenant and a landlord wherein the landlord agrees to lease a property to a tenant for a certain period of time, after which the tenant can purchase the property.
Rent-to-own is often seen as a more affordable way into homeownership because the buyer avoids many of the high startup costs associated with purchasing a home. However, rent-to-own agreements come with their own costs, and potential renters should be sure they fully understand what a particular rent-to-own deal entails before signing the contract.
How Does Rent-To-Own Work?
Rent-to-own contracts often utilize what is known as a lease option agreement. A lease option is made up of two parts.
The first part is a standard lease, which means a tenant rents a home and pays monthly rent and expenses to a landlord. The second part is the “option,” which locks in certain terms that allow the tenant (home buyer) to buy the home from the landlord (home seller) when the lease term ends.
In some cases, the contract may state that, rather than having the option to purchase the home, the renter is obligated to purchase the home at the end of the leasing period. This is known as a lease purchase agreement.
Let’s take a look at some of the finer points of these types of contracts below.
The Lease Agreement
The first part of a rent-to-own contract, the lease agreement, is a contract between a lessor (landlord) and lessee (renter) that allows the lessee to use a property for a designated amount of time. This agreement does not provide any ownership rights to the lessee, and as with any lease contract, most points are negotiable.
While every contract is different, here are some things you can expect to see in every rent-to-own agreement.
The Lease Term
These types of leases are often set up to last one to three years. Buyers generally prefer longer terms – even as many as 5 years – because it gives them more time to strengthen their credit score and save for a down payment.
The contract will specify how much the tenant will pay in rent, when rent is due, what happens if rent is late and what percentage of the monthly rent payment will be credited toward the eventual home purchase.
With a rent-to-own home, tenants may pay a little bit more in rent than what is typical in the area, to account for the extra money that’s being set aside for their future purchase.
Repairs And Maintenance
In a traditional lease agreement, it’s usually the landlord who is responsible for property maintenance and making any necessary repairs that may come up over the course of the lease. This isn’t the case with most rent-to-own agreements.
With a lease option or lease purchase contract, it’s the tenant who is required to keep the home maintained, complete repairs and pay for any related costs that may come up.
It’s important to decide upfront how security deposits will be used and returned at the end of the lease. At the end of the leasing period, this deposit can typically be returned to the tenant or credited toward their home purchase unless circumstances permit the landlord/seller to keep it.
The Option Agreement
This portion of the contract gives the tenant the right to purchase the rental property once the lease ends. As part of this agreement, the tenant/buyer and landlord/seller will negotiate and come to an agreement on a few vital points.
The tenant and landlord can agree to a purchase price when they first enter the agreement or decide that the home will be priced at market value once the lease ends.
Often, tenants prefer locking in a price from the start since home prices generally go up. However, landlords will often bake a certain amount of appreciation into the price to make up for this.
The Option Fee
A rent-to-own agreement is going to cost more for a tenant than a traditional lease agreement. If the tenant wants the option to purchase the home once their lease is up, they’ll need to pay for that privilege. This is what’s known as the option fee.
Landlords will typically require an option fee equal to a certain percentage of the agreed-upon purchase price. Depending on the agreement, some of this money may be applied to the home purchase if the tenant exercises their option to buy.
Option fees are usually nonrefundable if a tenant decides not to purchase the home.
The Option Period
This is the time period when a tenant can exercise their option to buy the rent-to-own home. In some contracts, the tenant can do so at any time during the lease. In others, it must be at a date specified in the agreement. Once the option period passes, the option agreement is null and void, and the tenant typically forfeits the option fee to the landlord.
Keep in mind – if you’re a tenant debating whether to exercise your option, you should still use the same best practices as any home buyer. Just because you’re familiar with a home and have an arrangement with the home seller doesn’t mean you should cut corners or limit your options.
Is Rent-To-Own A Good Idea?
There are pros and cons to a lease option for both the seller (landlord) and potential buyer (tenant) of a house. Whichever side you’re on, it’s highly recommended that you hire a real estate attorney to draft the necessary documents and learn about your rights.
If you’re a home seller, offering a lease option allows you to expand your list of potential home buyers. Depending on the housing market in your area, it can sometimes be difficult to find qualified buyers. When you list your home as rent-to-own, those who want to buy a home but need more time to secure a mortgage or save for a down payment become potential buyers, so you can sell a home that you might not have been able to otherwise.
These agreements can also be financially beneficial for the seller because you’ll be able to collect rent from your tenant during the leasing period. Plus, rent-to-own tenants tend to be a bit more conscientious when it comes to caring for the property, as they plan to buy it at the end of their lease.
As a home buyer, the biggest advantage to rent-to-own is getting to move into a desirable home while getting some extra time to qualify for a mortgage or save for homeownership.
If the purchase price for the rent-to-own home is agreed upon up front in your lease option agreement, you can also save on the purchase price if the home appreciates in value by the time your lease ends.
If you’re the home seller, a lease option means that you’ll need to become a landlord. Though you might not have quite as many responsibilities as a traditional landlord, since rent-to-own contracts typically stipulate that the renter is responsible for things like repairs and maintenance, you’ll still need to take care of collecting rent and ensuring that you’re fulfilling all your contractual obligations.
Additionally, if the tenant walks away at the end of their lease, the seller must then invest more time, energy and money to try and sell the home all over again.
There are risks on the tenant’s side, too. If you’re a tenant who does not end up buying the home for whatever reason, you’ll likely forfeit your option fee and potentially other money you’ve put into the home as well.
It’s also possible that home values could go down. If you agreed to a purchase price when you first entered the contract and the home is worth less than that when it’s time for you to exercise your option to buy, you’ll either have to buy the home for more than it’s worth or walk away and lose money.
Another nightmare scenario: your landlord ends up in financial hot water and loses the house to foreclosure. In this situation, you could lose your money and your home though no fault of your own.
How To Find Rent-to-Own Homes
Many homes are designated as rent-to-own by owners and can be searched for directly online.
If you’re interested in a lease option to buy a home, you may need to seek out homeowners who have started renting out a property because they were unable to attract an offer at their asking price.
The Bottom Line
Sometimes it’s tough for buyers to find financing or for sellers to find buyers. A lease option can solve for both and is worth exploring if you’re stuck in real estate limbo.
Before you sign a rent-to-own agreement, however, remember that it’s essential to consult a qualified real estate attorney who can clarify the contract for you and help you understand anything that might be confusing.