What is Lease to Own?
Lease to own homes or Rent to own homes is a way to buy or sell something over time, giving the buyer an option to purchase at some point in the future. With a traditional home purchase and sale, the buyer and seller complete the purchase more or less immediately after agreeing to terms at closing. Under a rent-to-own agreement, the buyer and seller agree to the possibility of a sale at some point in the future. Ultimately, the renter/buyer decides if the transaction will actually take place. In the meantime, the seller receives payments, and a portion of those payments usually reduces the money needed to buy the house at a later date
Why Buy With Rent to Own?
Rent-to-own programs can be attractive to buyers, especially those who expect to be in a stronger financial position within a few years. Here are some of its benefits:
- Buy with bad credit
- Lock in a purchase price
- Test drive
- Move less
- Build equity
Buy with bad credit: Buyers who cannot qualify for a home loan can start buying a house with a rent-to-own agreement. Over time, they can work on rebuilding their credit scores, and may be able to get a loan once it’s finally time to buy the house.
Lock in a purchase price: In markets with increasing home prices, buyers can get an agreement to buy at today’s price with the purchase taking place several years in the future. Buyers have the option to back out if home prices fall, although whether or not it makes sense financially will depend on how much they have paid under the agreement.
Test drive: Buyers can live in a home before committing to buy the property. As a result, they can learn about issues with the house, nightmare neighbors, and any other problems, before it’s too late.
Move less: Buyers who are committed to a home and neighborhood (but unable to buy) can get into a house they’ll eventually buy. This reduces the cost and inconvenience of moving after a few years.
Build equity: Technically, renters do not build equity in the same way homeowners do. However, payments can accumulate and provide a substantial sum to be put toward the home’s purchase. Buyers can also save money in a savings account and just use those funds—avoiding the pitfalls of rent to own, and providing the ability to buy any house.
Why Sell With Rent to Own?
- More buyers
- Earn income
- Higher price
- Invested renter
Land Owner Financing: How Does It Work Here At Eagle Rock REI, LLC?
More buyers: If you’re having trouble attracting buyers, you can also market to renters who hope to buy in the future. Not everyone has good credit and can qualify for a loan, but everyone needs a place to live.
Earn income: If you don’t need to sell right away and use the money for another down payment, you can earn rental income while moving toward selling a property.
Higher price: You can ask for a higher sales price when you offer rent to own. People may be willing to pay extra for the opportunity. Renters also get the option to buy the house—which they might never use—but flexibility always costs more.
Invested renter: A potential buyer is more likely to take care of a property (and get along with neighbors) than a renter with no skin in the game. The renter/buyer is already invested in the property and has an interest in maintaining it.
How It Works
Here is the structure of the typical rent-to-own agreement:
Everything is negotiable: A rent-to-own transaction, also known as a lease option, starts with the contract. Both the buyer and seller agree to certain terms, and all the terms can be changed to fit everyone’s needs. Depending on what’s important to you (whether you’re a buyer or seller), you can request certain points before signing an agreement. For example, you might request a larger or smaller up-front payment if that would help you.
An option to buy: At the beginning of any rent-to-own transaction, the buyer typically pays the seller an option premium, either a fixed amount or often around 5% of the ultimate purchase price . This payment gives the buyer the right or “option”—but not the obligation—to buy the home at some point in the future.
No refunds: The initial premium payment is non-refundable, but it can be applied to the purchase price and if the buyer ever buys the home, they won’t have to come up with as much cash. Larger option payments are risky for buyers: If the deal doesn’t go through for whatever reason, there’s no way to get that money back. The seller typically gets to keep any premium payments after a rent-to-own transaction ends.
Purchase price: The buyer and seller set a purchase price for the home in their contract. At some point in the future (usually between one and five years, depending on negotiations), the buyer can purchase the home for that price—regardless of what the home is actually worth. When setting the price, a price that’s higher than the current price is not uncommon (otherwise, the seller is better off just selling today). If the home has gone up in value faster than expected, things work out in the buyer’s favor. If the home loses value, the renter probably won’t buy the home (partly because it might not make sense, and partly because the renter might not be able to qualify for a large loan with a high loan-to-value ratio). Buyers usually apply for a mortgage when the time comes to purchase the home.
Monthly payments: The buyer/renter also makes monthly payments to the seller. Those payments serve as rent payments (because the seller still owns the property), but the renter typically pays a little bit extra each month. The additional amount is usually credited to the final purchase price, so it reduces the amount of money the buyer has to come up with when buying the home. Again, the extra rent “premium” is nonrefundable—it compensates the seller for waiting around to see what the buyer will do. The seller can’t sell the property to anyone else until the agreement with the renter ends.
Maintenance: Everyone involved benefits from a well-maintained home, but who should pay? Your agreement should specify who is responsible for routine maintenance and extensive repairs. Some agreements say that anything under $1500+ is the responsibility of the buyer, but local laws can complicate matters. Landlords might be required to provide certain services, even if your agreement says otherwise.
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