A Brief Introduction About the Lease to Own Contract
A Lease to Own Contract is a contract that is applicable when tenants wish to rent properties for a certain period, generally multiple years, while having the option to purchase a property at or before the end of the lease. These contracts are beneficial toward tenants for a variety of reasons. For example, tenants might not have a down payment or insufficient earnings to obtain a loan. Also, their credit scores might not be high enough, or they might not be ready to commit to homeownership.
If you wish to purchase a home, but your credit score is not high enough, renting a property with the choice to purchase it later starts you on a path to homeownership. Additionally, it is a great choice for renters who wish to purchase a particular home but cannot do so right away.
In a slower market, lease to own contracts provides sellers additional options while securing a steady earnings source. If you have a hard time selling a property in a slow market, these contracts could enhance your cash flow until you sell the property.
It is also known as Lease with Purchase Option, Lease with Option to Buy, Lease Purchase, Lease-Option Agreement, Rent-to-own contract.
You must use this contract document if:
- You are a property owner eager to sell a property toward the renter when the lease expires.
- You are a tenant preparing the document to share with your landowner.
Who Takes the Lease to Own Contract?
A Lease to Own Contract agreement is similar toward a typical residential lease agreement in that it sets up all the vital terms of a lease or rental agreement amid a landlord and tenant. Also, it permits the tenant the option to eventually buy the apartment or house when certain conditions are met.
It is also known as a Lease with Option to Purchase Agreements or Lease to Own Agreements, that permit renters who are working on improving their credit to move into a house they would have the option to buy at the end of the lease term. It also assists the landlords to rent properties that they have been having a hard time selling or renting.
Purpose of the Lease to Own Contract
A Lease to Own Contracts includes everything a standard lease generally contains as well as the terms of the option to buy agreement. There are some exclusive advantages for both parties in this sort of lease arrangement.
This contract (or rent-to-own) is a usually rental agreement where the tenant rents the property with the choice to purchase it at the end of the lease term. These agreements make it simple and more enticing for the tenant to purchase your rental property. The agreements are normally used in the following two situations:
- The landowner is having a difficult time selling the rental property
- The landlord already bought a new home and is looking to rent or sell the old house
Contents of the Lease to Own Contract
A lease to own contract consist of everything a regular lease does as well as the amount of the option fee, termination details, what takes place when extra rent is paid, and whether the house would have a set price or be sold at market value.
- Option fee: This fee is, as a rule, one to five percent of the cost of the home. In many leases to own contract, this fee is to reserve your “option” to purchase the property and might go towards your down payment or equity.
- Additional rent: It sets the rent rate two or three hundred dollars higher each month than the going rate.
- Termination: This part of the lease to own contract is extremely vital for both parties. It details relating to how a renter might breach their lease, how a renter could quit the lease, and the landlord obligations.
- Home sale price: Some sellers and buyers concur on what the sale price shall be when making this agreement. It can be current market value or projected prices. Some choose not to set the cost until the time the actual purchase is to take place.
How to Draft the Lease to Own Contract
It lists the same elements seen in a normal lease agreement, for instance:
- Due date as well as a monthly payment
- Late fees as well as grace periods
- Description of property
- Homeowner as well as tenant information
- Term of the lease
The following rental terms to identify in your lease to own contract are:
- Length of Rental Lease: The length of the lease is vital because the tenant would have the option to purchase the property at the end of the lease. The lease end date is also mostly the purchase date.
- Price of Property: Usually, the price of the property is stated when you sign the lease-to-own agreement. Landlords, as well as tenants who are entering a lease-to-own agreement, must discuss what would happen if the value of the home changes considerably during the lease term.
- Option Fee: The option fee is paid through the tenant to secure the option to purchase the home at the end of the agreement. Option fees are normally non-refundable.
- Rent Credit: This is a basic monthly fee that goes towards the tenant’s down payment if the tenant wants to purchase the home. This fee is normally non-refundable, so if the tenant wants not to purchase the property, then the landowner keeps the money.
Also, it includes details, which contains:
- A portion of the rent going toward the purchase price
- Fines if the agreement is violated
- The way the property cost shall be assessed
Negotiation Strategy
In this contract, the sellers tend to offer a rent to own option if they do not propose to sell the property, or in the following matter:
- A contract comes with a higher sales price if the market declines
- An agreement lists tenants who properly care for the property
- An agreement possesses a longer rental term that has steady earnings
- The seller has a positive cash flow on the property
- The contract comes with minimal risk and an option fee that’s not refundable
Furthermore, a seller might place additional rents into a safeguarded escrow account that would go to the down payment. Certain sellers might place additional funds that are paid off toward the purchase price of the property. It also has no commission that requires to be paid to brokers. In case the property has a difficult time being sold, it can be a sound way to sell the property later. Additionally, rent received with the option fee is likely to be above the market average.
Benefits and Drawbacks of the Lease to Own Contract
Benefits of this contract are;
In many situations, most of the benefits are on the seller’s side. However, there are still a few advantages to the potential home buyer.
Benefits for the seller:
In a down market, this contract could be a good opportunity to boost cash flow from leasing a property that was otherwise vacant or hard to sell or rent. Most lease agreements are long-term, and the rate of rental is often higher than average, so this could be an advantageous arrangement for property owners.
Benefits for the buyer:
This contract could give the buyer a couple of years to work on improving their credit as well as raising their down payment leverage. If the contract includes the selling cost of the house, the price is locked in even if the market improves.
Drawbacks for the seller:
You cannot sell the house if the market improves, and you are still within the terms of the agreement. In case the contract contains the sales price, you cannot raise the price. In case the buyer backs out and does not improve their credit, you left with a vacant rental.
Drawbacks for the buyer:
If your credit score does not improve, you can lose the option fee and the years of extra rent paid. On the other hand, something might happen that is out of your control, which could affect your capability to purchase, such as job loss or a serious illness.
What Happens in Case of Violation?
In this contract, until the right of the purchase is carried out, the property is legally owned by the landlords. Although tenants are accountable for all the repairs and maintenance, they still have to conform to all of the conditions of the rental agreement. This means that tenants may not have unauthorized residents or pets if the lease explicitly specifies that.
However, in a lease to own contract, if the tenant violates the terms of the contract, the buy option is voided. The tenant would lose the option fee and the escrow percentage of the monthly rent payments.
This contract is required to be carefully reviewed before signing by the parties. This agreement is expensive, as well as long-term, so it warrants a diligent review. If everything goes well, renters could build their credit while the seller could benefit from two or three years of rental income during the lease period in a lease to own contract(1). At the end of the contract, in the best situation is that the seller sells a difficult-to-sell property, and the new owners get to enjoy the advantages of homeownership.