How does renting to own work?
- A rent-to-own contract, or a lease purchase, may refer to a contract where the buyer is legally obligated to purchase the property at the end of the lease.
- A lease with option to purchase, or a lease option, gives the buyer the right to buy the property at the end of their lease term. In other words, the buyer is not contractually obligated to purchase the home.
The terms rent to own and option to purchase are sometimes used interchangeably, so regardless of what you call it, both the seller and the buyer should be clear about the nature of the contract before signing it. In particular, the buyer should be aware of the terms and conditions so they do not mistakenly agree to buy the home when the lease ends.
How to create a rent-to-own contract
The pros and cons for sellers
- It can be difficult to find a buyer in a slow market. If you want to move but cannot afford to do so until you sell your property, a rent-to-own arrangement can generate cash flow to offset your current mortgage payments, allowing you to move to a new home.
- You can often set a higher purchase price on your home than the current market value. The option to purchase offers flexibility that potential buyers may be willing to pay a premium for, meaning you may be able to sell your property for a price higher than if you simply sold it outright.
- If you do not need to sell right away, renting to own has financial advantages, including an additional stream of income and tax deductions from being a landlord.
- In many cases, the tenant will take better care of the home knowing they may own it at a future date.
- If the tenant decides not to purchase at the end of their lease, you (the landlord) usually get to keep the option fee.
Because the purchase price is fixed once the agreement is signed, your profit is also fixed. If home values go up, you are still obliged to sell your property at the price specified in the contract.
If the tenant opts out of their option to purchase at the end of the lease, the seller must go through the process of finding a buyer once again.
The pros and cons for buyers
- If you don’t have enough for a down payment or cannot qualify for mortgage financing due to bad credit, renting to own can help get you on track. While you rent, you can work to improve your credit score as well as build equity in the home.
- You get to experience homeownership and decide whether it is a good fit for your lifestyle. You also have the chance to test out the neighborhood or area before committing to a longer term arrangement.
- If you decide to exercise your option to purchase at the end of the lease term, you can buy the home for the price you settled on when you created the agreement, regardless of whether real estate prices have gone up.
- Whether you decide homeownership isn’t for you or you don’t qualify for a mortgage, in most cases, you can opt out of the purchase at the end of the lease.
Because rent credits are being applied to your monthly rent, the seller can charge more than the market rate. Consequently, your monthly payments will be higher than with a traditional rental agreement.
Even if you want to buy the home, you may be unable to exercise your option to purchase if you do not qualify for mortgage financing at the end of the lease term.
In most cases, you forfeit your option fee and any rent credits if you opt out of the purchase.
There is a risk that the home will be foreclosed before you can buy it, as there is no guarantee the owner will continue to make mortgage payments while you are living there.
Buyer tip: Avoid the risk of foreclosure by inquiring about the mortgage payment history before signing your lease agreement. You should also inquire about any liens against the property with a title company or at your county recorder’s office, as this can affect the transfer of title from the seller to the buyer.