How a Lease Option to Buy Works
If you'd like to buy a home right now but don't qualify for a mortgage because of credit problems, lack of a down payment or insufficient income, a lease option -- also referred to as rent-to-own or lease purchase -- might be your ticket to home ownership. The process can be advantageous for both the buyer and the seller, but it can also result in more costs than benefits to the prospective buyer if the contract is more heavily weighted in the seller's favor.
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Initiating the Deal
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A lease option is generally initiated by the landlord through his advertisement of property availability for a lease option. The application process is essentially the same as that for a standard rental: the landlord typically requires information from the applicants regarding credit and income. If a tenant is selected for tenancy, he often signs the lease without negotiating any or many changes because most lease provisions are standard and some are mandated by law. A lease option may also be signed without changes; however, it is critical that the tenant-buyer fully understands each lease clause and negotiates contract amendments if he finds terms that will benefit the seller at his (the tenant-buyer's) expense.
Responding to the Option
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Once the contract is signed, the tenant-buyer moves into the property. She must decide whether to exercise her option to buy the property before the option expires. After the option expires, she may continue to rent the property under the terms of the lease or she may terminate the lease. The owner is not obligated to sell the property after the option expires.
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Contract
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A lease option combines the features of a standard rental agreement with an option to purchase the property you are renting. There is no universal contract for a lease option. Important aspects of the contract include the property price or a process to determine the price; how much, if anything, is charged for the right to participate in the option and whether that fee is refundable if the option is not exercised; when and for how long the option for purchase is available; and what, if any, portion of the rent applies to a down payment and whether that portion of rent is refundable if the tenant fails to exercise the option. A lease option obligates both the landlord and tenant in the rental of the property; it obligates only the owner in the option. The tenant-buyer can choose whether or not to exercise the option.
Trade-Offs
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In an appreciating real estate market, it is beneficial to the tenant-buyer to have the property sales price listed in the contract. He benefits from the price appreciation while renting the house and will immediately have equity exceeding his down payment the moment he buys the property. In a declining real estate market, it is beneficial to the tenant-buyer to have a process described by which the property value will be determined at the time of sale: the price will go down and he will not be buying a house worth less than its sales price. The tenant-buyer cannot expect the seller-landlord to lock in a sales price in an appreciating market without paying some cost -- either in the form of a non-refundable option fee, higher than market-rate rent or both. The tenant-buyer, however, must realize that he may change his mind about buying or may not qualify for the mortgage by the time the option expires. Therefore, he should not agree to an option fee and rent so far above market rate that those two situations don't balance the benefit of the option with the risk of not purchasing the property.
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References
- Photo Credit for sale by owner image by dead_account from Fotolia.com
