Lease-to-own, also known as rent-to-own or lease purchase, is a type of home purchase that appeals to very specific buyers and sellers. A buyer with little cash and poor credit appreciates the opportunity to live in the home he intends to purchase, even while he’s working to improve his finances. A seller who needs cash flow but wants to wait for home prices to increase kills two birds with one stone — rental income early on and either a sale under the lease-to-own agreement or additional money to tide her over until the home sells if the tenants decide not to buy.
How Lease-to-Own Works - Lease-to-own is two transactions in one: a rental agreement plus the option for the buyer to purchase the home at the end of the lease term. First, the landlord and tenant -- the parties to the agreement -- settle on a purchase price, a rent amount and a lease term. The lease term is usually one to three years. In addition, the parties agree to an additional rent amount the tenant will pay monthly. The landlord will credit this additional amount toward the purchase of the home. And, in addition to the usual first month's rent, last month's rent and one month's rent worth of security deposit, the tenant pays an option fee to the landlord that generally equals 3 to 5 percent of the purchase price. The option fee is a nonrefundable deposit. If the tenant purchases the home at the end of the lease, the landlord credits the amount of the option fee. If the tenant doesn't purchase at the end of the lease, he forfeits the option fee and the additional rent monies he paid. The lease-to-own agreement specifies the date by which the tenant must purchase the home. The date is usually the date the lease ends, so the tenant must have secured financing and saved any additional down payment his lender requires before that date.
Work Out the Financing - The tenant needs to determine how much cash she has available for the rent deposits and purchase option and how much she can afford to pay each month toward housing. Of the amount she can pay toward housing, she must factor in rent, the additional payment that goes toward the purchase, plus taxes, insurance and maintenance, as she likely will be responsible for paying these items on the landlord's behalf. The landlord/seller must determine how much he needs to collect in rent and how much he needs to net from the eventual sale.
Find or List a Home - If you're planning to buy a lease-to-own or sell one, your first step should be to contact a real estate agent to request listings for homes or to list your home. The agent will discuss with you the pros and cons of lease-option transactions and recommend that you speak with an attorney once you're about to go under contract. For buyers and sellers who'd prefer to go it alone, use a website that allows sellers/landlords to market homes directly to buyers/tenants.
Negotiate the Contract - Once you've found a home or a tenant for your home, it's time to negotiate the lease and the option. Lease options most often favor landlords. If the buyer decides not to purchase the home or is unable to, the landlord still has the option fee and additional rent payments in addition to the tax benefits of renting out his home. The primary risk to the landlord is that of a declining market -- the possibility that depreciation will reduce the property value more than the landlord can compensate for with the option fee and additional rent payments. The primary risk to the tenant is the likelihood that the financial hurdles she faces going in will still plague her when it's time to exercise the option, rendering her unable to buy. In this case, she forfeits the option fee, the additional rent and money she invested in maintenance and property insurance. Once the parties have come to an agreement about the terms of the contract and had their attorneys review the documents, the tenant and landlord sign the contract and the lease is in effect.
Exercise the Option - If the buyer secures financing and whatever additional down payment money she needs in order to exercise the option, and she chooses to exercise it, she must let the landlord know before the deadline their contract specifies. The landlord must accept the tenant's decision, although, as noted, he retains the option fee and additional rent amount if the tenant doesn't exercise the option.