You’ve heard of a car lease, but what about a lease-to-own home? In this scenario, a tenant agrees to a lease with an option to purchase the property down the road, typically no more than three years from signing the agreement. Set forth within that document are the rental payment amount, accrual toward down payment and the home’s sale price. But does this make sense for your personal financial situation?Many who enter into these agreements do so because issues such as lack of a down payment or credit problems may block them from a traditional purchase. In a nutshell, they are able to use the rent they will pay before purchasing as their down payment.
However, there are a few risks to consider up front: Primarily, the lease-to-own industry has been pockmarked with less-than-ethical dealings, and consumer protections have been slow to emerge in response. That said, it can simplify the ownership process for people who wish to buy but find themselves in a tough financial spot.
Renting to own is not a terribly common choice. In fact, according to the 2016 Profile of Home Buyers and Sellers produced by the National Association of Realtors, just 1% of those purchasing a home in 2015 were renting to own.
Lease-to-own homes: What’s the process?
You’ll choose between two types of rent-to-own arrangements:
- A lease-option agreement, which requires a nonrefundable deposit at the beginning of the lease term as part of the purchase price — money that will be kept, should the tenant decide not to buy the property
- A lease-purchase agreement, which does not require that any money be paid upfront, but is more concrete in what it sets forth, including when the purchase price will be decided and a date when the sale will take place
Throughout the life of the lease, you’ll be paying rent as you would with any standard tenant agreement. However, the meat of that agreement is different than with your typical landlord-tenant contract, as it spells out terms under which you as the tenant will eventually purchase the property.
Sounds great in theory, but how does it work in reality? If you have a lease-option contract, you’re on the hook to find financing to pay off the balance of the purchase price — and if you can’t, you’re out any money paid up until that point. This gets dire if your contract is lease-purchase, as you could be sued if you can’t or won’t buy the property as agreed.
“You might be told it’s a chance to ‘stop throwing money away on rent,’” Federal Trade Commission consumer education specialist Amy Hebert wrote in an online brief. “But we’ve heard that many people who thought these deals were a path to owning a home watched their dreams disappear instead.”
Understanding lease-to-own contracts
When you sign a lease-to-own contract, it will include:
- The lease or rental agreement, which stipulates that the landlord will retain the title to the home until the tenant exercises the option to the property. Like a typical rental agreement, it also includes terms like the amount of monthly rent, the lease period and the division of maintenance and repair responsibilities between landlord and tenant.
- The option provisions, which include purchase price, the amount of time the tenant has to complete the transaction, the option fee, which is typically 1% of the purchase price and rent credit, a 10% to 15% premium above market rent that is collected by the seller and rolled into the down payment when the purchase goes through.
- The purchase provision, which must denote the option fee, the purchase price and the duration of the option period.
What to do before signing a lease-to-own contract
Before signing on the dotted line, you need to take the following steps:
- Have an attorney review the agreement — local knowledge is key, as different states have differing laws about rent-to-own contracts — and have him or her rework it to be as favorable to you as possible.
- After your attorney gives his or her approval, get in touch with a lender. Make sure the lender also reviews the contract, and ask to be prequalified; both steps will give you more reassurance that you will be able to handle the purchase down the road.
- Get a qualified appraisal and inspection before signing anything so that you know exactly what you’re dealing with upfront.
Pros and cons of lease-to-own home programs
Benefits of these programs include:
- Buying without having to qualify for a traditional mortgage
- Building equity in your home before the actual purchase
- Locking in current prices in an escalating market
- Testing the neighborhood out before committing to it
- Saving the hassle of a move later on
- Being made to save a down payment through rent credits
However, there are drawbacks.
If you fail to qualify for a loan at the end of the lease, be prepared to lose money that you’ve invested through an option fee, rent credits and rent itself, making the property a rental for which you’ve paid above market rate for no return.
Some contracts specify that you are legally obligated to purchase the home at the end of the lease, so if you’re not careful, you can get yourself into legal issues with a contract that you aren’t able to honor.
The dark side of lease-to-own programs
The lease-to-own industry has had its share of controversy. In her online brief, Hebert writes: “In a rent-to-own deal, the person or company that owns a home agrees to sell it to you in the future for a specific price. Rent you pay now is counted toward your future down payment on the house. But these deals can be risky — and even flat-out scams.”
Such scams, as outlined by Hebert, include finding out the following.
- The property owner has failed to pay taxes on the home
- The seller does not truly own the property
- The house is a foreclosure
- The home is in poor shape or has major issues like asbestos or lead
- Promised repairs are not made after the signing of a contract
Moreover, a National Consumer Law Center report finds that land contracts, which proved popular with investors because borrowers who defaulted were without traditional mortgage protection and could be rapidly evicted — preyed largely on African-American, Latino and immigrant populations. These contracts, which placed the responsibility of upkeep on the renter (and would-be owner), were also deemed as “a transaction built to fail.”
The lesson: Buyer beware. Watch out for scams.
While rent-to-own contracts may seem appealing as an alternative to traditional home purchases, those looking to sign such an agreement should proceed with caution. This may be a worthwhile option for consumers who have a clear path to homeownership but a few temporary barriers to getting started. But it also can be risky, controversial and downright dangerous for the wrong people in the wrong situation.
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