We spend a lot of time debating when you know it’s a good time for you to buy a home and, sometimes, offering gentle reminders that it can be smart to rent.
But there’s another option: One that melds the pros and cons of both home ownership and renting.
You’ve probably seen rent to own furniture or appliances marketed to people without established credit. But in many parts of the country there are rent to own real estate markets, too — if you know where to look.
“Rent to own” is the description you may see in classified ads, but the legal term for this arrangement is a lease option. A lease option combines two real estate transactions: a lease and an option to purchase a property. This strategy can be attractive to renters who want to buy a home but don’t yet have a down payment saved up or otherwise may not qualify for traditional financing.
How renting to own works
With a lease option, you sign a lease contract and an option contract (the two are sometimes combined onto one form). The lease period typically ranges from one to three years.
In order to qualify for the option to purchase the property, you must pay a non-refundable option fee to the owner of the property, at the beginning of the lease term. The option fee is negotiable — often several thousand dollars or up to three percent of the specified purchase price.
If this sounds risky, it is. But the option fee is an essential aspect of the lease option: the consideration that gives you (and no one else) the right of first refusal to purchase the property in the future. Should you buy, the option fee is credited towards the purchase price of the property.
The purchase price is pre-determined and agreed upon in the original contract. Property owners who utilize lease options typically calculate the purchase price considering a historic value of appreciation, which may or may not be accurate come the option date. Luckily, you do not have to exercise the option to purchase a property with a lease option; you have the right, but not the obligation, to do so. Once the specified option time comes, you either exercise the option to purchase the property, or the lease expires and you move out. Some property owners allow for extensions of the option, with additional option fees.
One misconception about lease options is that a portion of the rent payments goes towards the purchase of the house. Rent payments are never applied toward the purchase price of a house. Additionally, lease options almost always put a great deal of maintenance responsibility on the tenant during the tenancy, which is an important factor to consider. After all, if you may own the home one day you’ll naturally want to keep it in the best condition possible.
Why you would want a lease option
Lease options can be attractive to sellers because it broadens the market of prospective buyers and gets somebody in the home and paying rent. But why would you want to buy a home using a rent to own arrangement? After all, there are cons:
- You must pay an option fee that you may lose if you don’t buy
- The seller has a lot of leverage in negotiating the purchase price — he or she can simply refuse a lease option
- You pay rent but may have greater responsibility for upkeep during the lease period
- You must still save up a down payment and qualify for a mortgage by the end of the lease period
Essentially, a lease option is attractive if you need additional time to save up a down payment or shore up your credit but you’re ready to settle into a particular home. Is a lease option a smart financial play? Probably not. But if you’re set on making a home sooner rather than later, it’s a tool that’s available.
What about you? Have you used lease options either as a buyer or a seller? Why?