What Is a Lease-to-Own Purchase?
A lease-to-own house purchase (also "rent-to-own purchase" or "lease purchase") is a lease combined with an option to purchase the property within a specified period, usually 3 years or less, at an agreed-upon price. Such arrangements have proliferated in the post-crisis market because many potential home buyers can’t meet the tougher loan qualification requirements today, and many potential sellers are unable to realize a satisfactory price in any other way.
Lease-purchase plans can be structured in such a way that both parties benefit. They can also be structured so that all the benefits flow to one of the parties and none to the other. Buyers especially need to be careful because they usually know less about the market than sellers, and the seller usually provides the contract.
Contract Features of a Lease-Purchase
In a typical arrangement, the borrower pays an option fee, 1% to 5% of the price, which is credited to the purchase price. The borrower pays a market rent, and an additional rent premium that is also credited to the purchase price. The option fee, option period, rent, rent premium, and purchase price are all negotiable items. If the purchase option is not exercised, the buyer loses both the option fee and the rent premium.
Buyers generally prefer a long option period because it provides more time to accumulate savings and repair credit. A long period can boomerang on them, however, if they are never able to exercise the option, since they lose the rent premium they have been paying all the while, in addition to the option fee. Sellers generally prefer a short option period, but if it is too short, the house won’t be sold.
The option fee and rent premium are viewed differently by buyers and sellers. To the buyer, they are part of the equity in the house they fully expect to own. To sellers, however, these payments are the best guarantee that their houses will sell; if they don’t sell, the payments are retained as income. That the benefit to the seller generally exceeds the cost to the buyer makes the lease-to-own deal a possible win-win.
A lease purchase contract may or may not give the renter/buyer the right to sell the option. This will have value to the buyer who isn’t completely confident of being able to exercise the option. It is a cost to the seller who prefers to retain the house and the monies collected.
Lease contracts may also contain provisions that nullify the buyer’s option, a point discussed below.
Using a Lease-Purchase to Buy
The lease-purchase offers homeownership opportunities to consumers who can't qualify for a loan from any source, but who are prepared to bet on themselves. The bet is that before the option period expires, they will qualify for the mortgage they need to exercise the purchase option. During the option period, they have the opportunity to rebuild their credit and accumulate savings while living in the house.
Even though it is costly, the right not to exercise the option is of value to buyers. If there is something seriously wrong with the house, neighborhood, or neighbors, the buyer can cut her losses by not exercising the option.
Dangers to Buyers
A major threat to buyers is contractual provisions that can nullify their option, such as the failure to pay the rent on the first day of the month. Such provisions are most likely to appear in contracts used by developers or firms that own multiple homes. One such firm in