Buying a home is a major purchase that many interested families or individuals simply can't afford. Instead of renting and waiting for home prices to fall, or their savings to accumulate, some would-be homeowners opt for a rent-to-own contract, also known as a lease-to-own arrangement, or simply a lease option. This type of contract combines some of the benefits of renting and owning a home, but it also carries new risks.
The purpose of a rent-to-own contract is to allow the tenant to eventually purchase the property outright from the landlord. Rent to own contracts resemble standard leases, but they apply a portion of each month's rent toward a predetermined price for the home. At the end of the agreement, the tenant has the option of getting a mortgage loan to pay for the remainder of the purchase price, or to allow the contract to expire and move out.
A rent-to-own contract includes all of the normal provisions of a lease agreement, including the amount of monthly rent, the landlord's liability for making repairs and providing utility service and the tenant's rights to privacy and safety. However, it also includes a purchase price for the home (known as the sale price), as well as a rent premium (the amount of each month's rent that goes toward the cost of the house) and an option fee, which is an up-front fee for the right to buy once the contract expires. The duration of the contract is known as the option. At the end of the option, the tenant must make a decision about whether or not to purchase the home.
Rent-to-own contracts have benefits for both landlords and tenants. Tenants who want to buy a home but have poor credit or can't afford a down payment can use the option period to repair a credit history through responsible borrowing and spending, or save up for a down payment on a mortgage loan that will cover the sale price. This increases the number of potential buyers, which makes it easier for the owner to eventually sell the property. It also gives the landlord additional income in the form of the option fee, which the landlord keeps regardless of whether or not the tenant buys the property in the end.
The main drawback with rent-to-own contracts is the added cost. Tenants are responsible for paying the option fee and usually pay more each month for rent due to the rent premium. If the value of the home falls, the sale price, which does not change, will represent a poor value and the tenant may choose to abandon plans to buy. For owners, a lease option may extend the length of time it takes to sell the property if other buyers would be willing and able to agree to a straight sale without first serving as tenants for the length of the option period.
Most tenants who have a rent-to-own contract ultimately decide not to exercise the option to purchase the property. This may be due to shifts in the market that makes the option a poor value, an inability to repair credit during the option period or a desire to move to a new location. Low-interest subprime mortgages and piggyback mortgages are among the options for home buyers who can't afford a traditional down payment or qualify for a conventional mortgage, but they carry their own share of risks. Only tenants who thoroughly research a rent-to-own opportunity and feel that they have a very high likelihood of being able to purchase the property will be likely to save money using a lease option.