Rent to Own or Lease Purchase…Is it right for you?
We’re hearing more and more of people looking for Rent to Own, Lease Purchase, or a Lease to Own. With more homeowners owning more then what the home is worth this might be an option for them to consider. Or if you are a buyer and your credit score might be a few points shy, a lease purchase might help you until you get the few points that are needed.
Whether you just short sale your home to avoid foreclosure and are looking to rent for a few years till you can purchase again (typically 2-3 years) or your credit score is a few points short and you need time to work on improving your score until you can get a loan, or you need time to save more money for a down payment, then a lease purchase might be helpful to you.
In the meantime, for most people the alternative is renting. Often, people will sign a two or three-year rental agreement and plan to buy a new home after the rental period is up. But is some cases there might be another option, which can be a good one: a rent-to-own agreement.
Now your probably thinking how does this work?
Often referred to as a lease-purchase option or a rent-to-own agreement is a rental agreement (lease) combined with an option to purchase the property within a specific period of time (usually 1-3 years) and at a specific price.
In exchange for the option to purchase the home, the renter pays what is known as an option fee – typically 1-5% of the agreed-on purchase price. Along with this option fee, there is also a rent premium (an additional amount that is paid above the typical rent amount. At the time the buyer decides to purchase the property, the option fee and all of the rent premium will be credited to the purchase price. If after the specific amount of time has passed that was determined at the beginning of the agreement, and the renter decides not to purchase the property and exercise his option right, then he/she will forfeit both the option amount paid and the rental premium.
The features of the rent-to-own contract, according to “The Mortgage Professor” (Jack M. Guttentag, a professor of finance at the Wharton School) include:
- “The sale price of the house and the rent are market-determined, yet subject to negotiation just as in a straight purchase or rental transaction.”
- “A lease purchase also may give the renter/buyer the right to assign the option to buy. This will usually have considerable value to the buyer, because it means that the option can be sold in the event that it has value but the buyer is not able to exercise it. It is a cost to the seller for the same reason.”
Now that we know what a lease purchase or rent to own agreement is, let’s consider the pro’s and con’s of it.
A longer option period, like two or three years might look great to give you more time to improve your credit score or get more money for a down payment, there is also more risk of loss. For example, if you have a one year agreement compared to a three year agreement, and you decide not to exercise your right to purchase you will lose more money with a three year agreement with the extra you have paid in rent premium.
Now a longer agreement would be good if you do exercise your right to purchase, with having more money for closing and more equity in the home.
A lease purchase agreement can be particularly compelling for people who are unable to finance a home purchase because of a recent short sale or low credit score. Now the risk and gamble you take would be that you would be able to increase your score in the amount of time of the agreement.
Make sure you read and understand the contract very carefully to make sure you are confident you can live up to all the terms, such as paying your rent on time, every time.
If your a home buyer or seller in the Eastern Pennsylvania area and are considering a lease purchase, give me a call to help you guide you through the process.
A lease option deal should cover and include everything that would be included with a traditional sale and contract, in addition to the penalties and recourse should one of the parties default in their end of the agreement.
Make sure you get everything in writing and included in a contract to cover both the buyer and the seller within the deal.
Most important, make sure you understand everything you sign. I would highly recommend getting a real estate agent or a lawyer to review and explain the lease purchase option and the agreement.
If done correctly, a lease purchase can be a win-win for both the buyer and the seller. But as with everything, buyer beware.
- Renting to Own…to Good to be True? (splitwise.com)
- Should You Consider A Lease With Option To Buy? (boldrealestategroup.wordpress.com)