Lease-to-Own vs. Rent-to-Own Properties
- A rent-to-own contract gives renters the right, but not the obligation, to buy the home they're renting at an agreed future date and price.
- Lease-to-own, also called lease purchase contracts, are similar to rent-to-own, but with an important difference: the tenant is required to purchase the home.
- For those looking to try out a house or neighborhood before buying, rent-to-own and lease-to-own can be great options.
Difference Between Rent-to-Own and Lease-to-Own
While some people use the terms rent-to-own and lease-to-own interchangeably, the terms differ in the level of obligation they impose. A rent-to-own contract allows the tenant to buy the home they are renting. Lease-to-own, also called lease purchase contracts, require the tenant to purchase the home after so many years or after certain conditions are met.
That said, rent-to-own and lease purchase agreements can be good alternatives for aspiring homeowners. These agreements help those who may have difficulty qualifying for a mortgage or need time to enhance their credit and FICO score to gain loan approval.
The Pros and Cons of Rent-to-Own
Time is on Your Side
Rent-to-own can be a great option for those looking to try out a house or neighborhood before buying. Rent-to-own allows renters to sample the best of both worlds, firmly sitting in the seat of a tenant, with no responsibility for property taxes or maintenance costs on the home, and trying on the role of the owner when considering whether to buy the house at the end of the rent-to-own period.
A rent-to-own arrangement also provides renters with time to accumulate savings for their down payment. This can be especially important for houses costing several hundred thousand dollars.
Recommended Read: Seven Tips to Help You Save For a House Down Payment
Lastly, a rent-to-own contract means that the renter has first dibs on the house, should they choose to make it their forever home. Therefore, not only will the renter be first in line ahead of any other offers, but the renter will also know the house's sales price, as stipulated in the rent-to-own agreement.
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But it Comes at a Cost
Rent-to-own contracts require that you pay your rent each month and a small payment towards your down payment. If, for instance, your monthly rent is $1,200, the rent-to-own agreement might require that an additional $200, or a total of $1,400, is paid each month. The incremental $200 payment is a rent credit and would be held in escrow as money towards your down payment, should you choose to buy the home.
For example, if the rent credit is paid for three years, then at the end of year three, the tenant would have $7,200 in escrow to apply toward the down payment for their mortgage.
Rent credits, however, don’t accrue to the tenant if the tenant doesn’t buy the home. If the tenant decides that they would prefer to remain a renter or to move from the house altogether and not purchase it, the rental credit will be forfeited and retained by the landlord as additional rent.
A second downside of rent-to-own is that the pre-set price of the house may look like a bad deal for the renter when it comes time to buy. For example, if housing prices fall between the date the rent-to-own agreement is signed and the expiration date, the renter will loathe making good on the sales agreement, reflecting a price that is too high relative to the market price. On the other hand, if housing prices rise precipitously, the buyer will rejoice at the immediate equity that will accrue upon sale.
Recommended Read: Am I Spending Too Much on Rent? Here’s Your Answer.
A final risk of rent-to-own agreements is that the renter might lose their right to purchase the home because of a lease breach. For example, imagine that the lease stipulates that no pets are allowed, and on a whim, you adopt a kitten that’s just as cute as a button.
While the landlord might not have anything against kittens per se, you have breached the lease by bringing one into the home without obtaining the landlord's written permission and amending your lease. Depending on your landlord, this breach might be cited as a breach of the rental agreement and your rent-to-own rights, leading you to forfeit the rent credit and your right to purchase the home.
The Pluses and Minuses of Purchase Lease Agreements
Purchase lease agreements are quite similar to rent-to-own contracts, with many of the same features, pros, and cons. For instance, when a tenant seeks to buy a house through a lease-purchase agreement, the tenant and landlord agree to a pre-set sales price for a future date. If a lease-purchase agreement is signed on December 1, 2022, and has a three-year lease period and home sales price of $300,000, the renter commits to buying the house at a sales price of $300,000 on December 1, 2025.
One of the biggest potential downsides in a lease-purchase agreement is that the tenant is bound by contract to purchase the home at the pre-set price rather than merely having the option to purchase it. In addition, if a tenant does not honor the commitment to buy upon the agreed date, the landlord’s recourse includes the right to take the tenant to court and sue for costs the rental credit does not cover.
A second downside of a lease purchase contract is that the tenant is often responsible for paying for property taxes and maintenance expenses that would ordinarily be the landlord’s responsibility. For instance, if the furnace decided to stop working on the coldest night of the year, you would have to deal with the problem, not your landlord.
A significant benefit of a purchase lease agreement is the ability for the renter to finish the lease term with a hefty down payment saved, by simply paying rent. In addition, the required rent credit for purchase lease agreements can be higher than for rent-to-own, giving the tenant a built-in monthly savings mechanism for their down payment.
Additionally, since the tenant has more certainty that they will buy the home versus a rent-to-own property, the tenant might be able to obtain concessions from the landlord. These could come in the form of upgraded appliances in the home, or permission to add design flourishes while living as a tenant, more in line with the renter’s tastes.
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Define The Details
Whether you buy a home through a rent-to-own agreement or a lease purchase, details matter. Take time to define the rent terms and conditions, purchase price, purchase date, down payment, and rent credit. The typical lease purchase or rent-to-own agreement terms is one to three years— long enough for the tenant to save towards the down payment and short enough for the sale price to still be in the ballpark and leave both sides feeling that it is fair on the purchase sales date. The incremental payment made towards your down payment, is usually not refundable; however, this should be approached in the spirit of negotiations with your landlord.
Rent-to-own and lease purchase agreements are binding contracts. Therefore, any concessions or changes to the agreements should be made in writing rather than verbally. Similarly, both the landlord and tenant should hire an attorney to review the agreement before agreeing to be bound by its terms and conditions.
The Money Wrap-Up
A rent-to-own or lease purchase contract can provide a good alternative when poor credit or an insufficient down payment stands in the way of obtaining a traditional mortgage loan. Renting-to-own can also provide a solution if you want to purchase a home, but hope to test out the neighborhood and evaluate it through the eyes of an owner before committing.
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