Rent-to-own contracts can be advantageous to both tenants and property owners. They enable tenants to repair their credit and prepare to get a mortgage, and they help owners find solutions in a tough market. However, both parties incur risks with this type of real estate contract.
The Rent-to-Own Lease
A rent-to-own contract is similar to a residential lease, except that it contains provisions for the tenant to purchase the home. Typical details in the contract include:
- The length of the lease period
- The amount of rent
- The amount applied toward the purchase price
- The obligations of the landlord and tenant regarding maintenance and general upkeep
During the rental period, the tenant must meet all the provisions of the lease. He must pay rent on time and care for the property as stated in the lease. During the lease period, the owner applies some of each month's rent to the purchase price. The tenant is in danger of eviction if he does not keep the terms of the lease, just as he would be in a normal rental situation.
Rent-to-own leases typically carry much higher rental payments than a typical property; the owner applies some of the payment toward the purchase price, but can also command a higher rent due to the tenant's wish to own the home.
Renters should insist that the extra rent be placed in an escrow account with a third party. That way the tenant is assured that the amount can be credited toward the sale price of the home as long as he is able to exercise his option to purchase.
Standard leases hold the landlord responsible for repairs, but rent-to-own contracts differ. In some cases, the tenant must make repairs during the lease period. However, some state laws require the owner maintain responsibility for repairs.
Before a tenant signs a rent-to-own lease, he should confirm with the county recorder that the landlord owns the home, that it is free of liens, and that the purchase price will pay off the mortgage.
The Option to Purchase Agreement
The owner may include an option to purchase agreement as part of the lease, or it may be a separate document. That agreement includes:
- The amount of the non-refundable option fee
- The purchase price of the home
- The terms of the option period
The option period may begin at the same time as the lease, or at a later time. In some cases, the landlord may prefer that the tenant complete the real estate transaction as soon as possible, so he will realize his profit. In other cases, the owner may hope to realize a greater profit if the contract allows his to adjust the sale price of the home if the market value increases.
Determining the purchase price of the home depends on tenant and owner negotiations. In some cases, both parties agree to a set purchase price, based on the home's current value. In other cases, the parties agree on an amount that is subject to change, depending on the market value at the time that the tenant is ready to purchase.
Tenants' Benefits and Risks
The tenant in the rent-to-own contract has both benefits and risks. The benefits include:
- Rental credits toward the purchase price
- The ability to move into and maintain the home as if it were his, even if he is unable to obtain a mortgage
- The possible benefit of setting the purchase price at current market value, in which case the renter will benefit if the value of the home increases and he completes the purchase as agreed
- The tenant is not legally obligated to buy the home -- if he wishes, he may move out, but he will typically lose his option fee and the extra rent he paid
The tenant's risks include:
- If he is unable to qualify for financing at the end of the option period, he loses his option fee
- If he cannot buy the home, he loses the extra amount of rent he paid during the lease period
- He may spend money on repairs and improvements that is non-refundable if he later decides not to exercise his option to buy
Owners' Benefits and Risks
Home owners also carry both benefits and risks with this type of contract. The owner's benefits include:
- A larger upfront deposit
- A greater amount of monthly rent, all of which he will keep if the tenant fails to exercise his option to buy
- If the real estate market is slow, he is able to find a buyer and collect an inflated rent while he waits for the contract to complete
- A tenant who is likely to take good care of the home, since his intent is to buy it
The owner's risks include:
- The tenant will damage the home by attempting do-it-yourself projects
- The tenant will be unable to complete the purchase option. This can be costly if the value of the home decreases, since he could have sold it to another buyer
- The owner is legally obligated to sell the home to the tenant, as long as he keeps the terms of the agreement and is able to obtain financing.