Tips on Lease Option or Rent-to-Own Purchase Agreements
Written by: Kristy Welsh
Last Updated: August 10, 2017
With the credit and real estate market enduring recent difficult times, what we normally consider a traditional real estate transactions are becoming few and far between. Contingent on the area of the country you reside, many real estate transactions today involve bank-owned, short sale or foreclosure properties. Homeowners who legitimately need to sell their homes are finding it increasingly challenging to find qualified buyers, and as a result are seeking alternative ways to sell, or at least obtain a source of income, from their homes.
What is a Lease Purchase Agreement?
One such method that some homeowners are utilizing is called a lease option or lease purchase transaction. Lease option sales have been around a long time, and were popular financing instruments in the late 1970s and early 1980s. A lease purchase sale involves a potential buyer locking in an option to purchase a property within a specified period, ranging from 1 to 4 years, at a pre-determined price. The buyer typically pays an option fee, 1 to 5 percent of the price, which is credited to the purchase price, and takes possession of the property as a renter. Part of each month's rent may be credited toward the purchase price, contingent on the contract. If the buyer decides not (or is unable) to exercise the purchase option, the buyer will most likely lose both the option fee and any accumulated rent premium.
The lease-purchase offers homeownership opportunities to individuals who can't qualify for a loan from any source, but feel as though they will be able to by the time the option period is complete. For potential homebuyers with poor credit or not enough cash for a traditional 20 percent down payment, a lease-purchase agreement may benefit them by allowing time to build equity until conditions improve and/or until they repair their credit sufficiently to qualify for a traditional mortgage. During the option period, they have the opportunity to rebuild their credit and accumulate equity while living in the house. The bet is that before the option period expires, they will qualify for the mortgage they need to exercise the purchase option.
Are Lease Purchases a Good Idea?
Lease purchase or rent-to-own contracts can be very risky, especially for the buyer. With home prices declining in many areas of the country, the premise of a potential buyer building equity, while paying rent towards the purchase price is no longer a given. Both buyers and sellers must beware of potential fraud and thoroughly investigate the property and parties involved prior to entering into one of these lease option agreements.
Before entering into any lease-purchase agreement, buyers and sellers should always obtain the advice of a real estate lawyer. We are not lawyers, and laws vary from state to state regarding lease purchase and lease option agreements so you will need to do your research for your property location. With that disclaimer, here are some general tips and advice regarding lease purchase agreements for both buyers and sellers.
- Have a thorough, airtight contract. Have a real estate lawyer draw up the contract, or at a minimum, have the contract reviewed by an expert in the field. A good lease purchase contract will address every potential pitfall that can occur while addressing terms associated with all minor details, such as who is responsible for home repairs, who pays for maintenance and what happens if the buyer misses a rent payment or the seller misses a mortgage payment. Another key element to address is to ensure the contract allows for renegotiation of price should unforeseen market changes threaten the deal.
- Do your due diligence on the seller. If you are the buyer, you will want to perform a background check on the seller including running their credit. Make sure they legitimately own the property.
- Do your due diligence on the property. As the potential buyer/renter, you should treat the transaction identical to buying a regular home sale, including an appraisal and all appropriate inspections and disclosures. The property might be encumbered by underlying loans that contain alienation clauses-- ensure that you or your legal representative performs a thorough check on any outstanding liens against the property including property taxes and that you examine the title policy in detail.
- Do your due diligence on the buyer. If you are the seller, you will want to thoroughly screen any prospective renter/buyers, including a credit check, employment status and salary history.
- Do regular property inspections. As the seller, remember you are still responsible for property taxes and insuring the property. Ensure that the property is being well cared for by performing regular inspections. If possible, include the allowance for regular property inspections into the contract itself.
Current trends suggest that lease purchases and rent-to-own transactions are on the rise, particularly in areas where the housing market has seen significant declines. Before entering into any type of lease purchase agreement with a seller, buyers should seek the advice of a real estate lawyer and obtain all associated information on the property and parties involved. Although there is some appeal to this type of transaction in these difficult economic conditions, lease-purchase transactions may offer benefits as well as risks to both buyers and sellers.