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What is a Rent-to-Own Contract?
A rent-to-own contract, also known as a lease-to-own agreement or lease option, is similar to a standard lease agreement, except at the end, the tenant can purchase the home from the landlord.
Usually, this is for a single-family home, and typically it is because of one of a few things:
- the landlord can’t sell the rental property
- the landlord has a new home and wants to get rid of the rental
- the tenant needs some time to save money to buy the house
A rent-to-own contract is, in part, a lease agreement between the landlord and tenant where the tenant will pay a little more than fair market value for the property each month. The overpayment is intended to lie in escrow until the end of the contract, when the renter has the opportunity to buy the home outright or walk away. This is considered a legal document.
Types of Rent-to-Own Contracts
Two main types of rent-to-own contracts can exist. One is a lease agreement with the option to purchase, and the other is a lease agreement with a purchase agreement.
- A lease with the option to purchase agreement. The name identifies this contract as an option to buy the home at the end. The word “option” in this form of rent-to-own contract is differentiating factor. If the tenant does not want to purchase the home in the future, they are not legally bound by the contract.
- A lease agreement with purchase agreement. Again, the name is the primary descriptor of this agreement option. This is a less flexible option of the two and requires or legally obligates the tenant to purchase the property after the lease portion is expired.
What’s Included in a Rent-to-Own Contract?
A rent-to-own contract is typically made up of two main components:
- a standard lease agreement
- an option to purchase
They are sometimes added together into one document. Still, they can be in two, and the landlord retains ownership over the property until the end of the lease agreement. This arrangement begins like any other lease agreement but ends with either the obligation or the option to purchase the home once that portion has expired.
Standard Lease Agreement
The standard lease agreement portion of the rental agreement is just as it sounds. For the most part, it is just what you would find in a regular residential lease agreement for a rental property. However, there are subtle differences between this form of lease and a traditional lease agreement.
Rent-to-Own Lease Agreement Vs. Traditional Lease Agreement
- Payment arrangements vary. In a traditional lease, the tenant must make regular payments on time and at fair market value. In the rent-to-own version of a lease, the rental payments are higher. This is because the extra portion is intended to remain in escrow to cover an eventual payment toward the sale of the house.
- Tenant has to make repairs on the rental property. In a traditional lease, the landlord should repair anything that breaks at their own expense. In this arrangement, that obligation falls on the tenant.
- Tenant is obligated to fulfill the lease. Until the tenant decides to buy the home in the end, they have to keep to the letter of the lease agreement. In this case, unlike traditional rental agreements, any violations to the lease agreement render the entire contract null and void. In a traditional option, a violation usually results in eviction. In this case, they would lose out on the whole deal. This likely means they will lose the extra money spent on the rent and any money spent on repairs.
- Home appraisal. Since the tenant will potentially purchase at the end of this form of agreement, they should order a home appraisal. Whether or not the home will be purchased, this is a crucial step because it gives the tenant a snapshot of the health of the house and ensures they will pay a fair price for the home in the long run.
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Option to Purchase
The option to purchase a portion of the rent-to-own contract is the part that outlines a tenant’s option to buy the property within a designated time frame for a fixed fee. The fee could be paid upfront or month-to-month by paying higher than the rental cost.
At the end of the lease portion, if the tenant decides not to go ahead with purchasing the home, the landlord is under no obligation to refund the option fee or any extra money spent on higher rent.
Since this is a high-stakes agreement for both the tenant and the landlord, the option to purchase needs to include all the components of this portion, including:
- outlining the option fee
- delineating the duration of the option period
- negotiating the eventual purchase price of the home
- checking compliance with state laws
So, what are the benefits of this type of arrangement?
What are the Benefits of a Rent-to-Own Contract?
Depending on whether you are a tenant or landlord, the benefits differ.
Benefits for Landlord
For a landlord, entering into an agreement of this nature makes the home's sale a more straightforward process.
- They can attract good tenants. Usually, tenants entering this type of agreement already have long-term goals in mind, so they are more likely to make sure the home remains in good repair while they are renting. In addition, they are more likely to make their rental payments on time since they are usually.
- They can lock in a purchase price. This portion is included in the option agreement. Since it is already delineated, the home is not subject to market fluctuations. The price stated in the agreement is the price eventually paid.
- They already have an upfront payment. Since a non-refundable option fee is applied at the onset of the agreement, the landlord already has cash with no obligation to refund.
- They have default protection built-in. For example, if the tenant decides to walk away at the end of the lease, the landlord does not have to refund the option fee. This helps deter potential homeowners from defaulting on the lease option at the end.
For the tenant entering into this form of agreement, there are benefits as well.
- They can save up money. The extra money paid in this arrangement is set aside for their eventual purchase, so they have time to “save up” for a down payment.
- They can improve their credit. Since monthly payments are applied each month, tenants can choose to report these payments to the credit bureaus to improve their credit score.
- They can earn equity on the home. Since the purchase price is already set in stone, if the value fluctuates to a higher price during the rental period, AND if they purchase the home, that difference in price counts as equity for the eventual homeowner.
The rent-to-own contract can essentially be a win-win for both parties involved if the contract is handled correctly. As with any legal document, entering into a contract should be held with the utmost regard.
If you are considering signing or drafting this type of agreement, enlist the help of a trained lawyer. Expert legal advice is paramount in ensuring both parties walk away with value.
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