Obtaining a Home through a Lease with the Option to Buy

If you're a first time home buyer looking for a house to buy, you may be familiar with the terms “rent-to-own” or “lease-to-own.” The lease-to-own option is an attractive way to obtain home ownership if you're having trouble with financing due to poor credit or employment history. Many homeowners who otherwise could not obtain a mortgage have realized the dream of home ownership through a lease with the option to buy. Whether or not such an option is right for you depends upon your circumstances.

Definition of Leasing with the Option to Buy

Leasing with the option to buy, also known as lease-to-own or rent-to-own is an arrangement where the potential home buyer leases a home from its current owner for a period of one to three years. At the end of the lease term the buyer has the option to purchase the house outright or walk away. These arrangements are entered into through a legally binding contract which takes into account all the details of the arrangement.

Reasons for Using the Lease-to-Own Option

From the seller's perspective, a lease-to-own contract may be attractive for several reasons. First, he may need to protect himself against having to make two mortgage payments if he buys a new house without being able to sell the old one. In such an arrangement the renter pays the mortgage on the original house, freeing the owner to pay the mortgage on his new house. Another possible scenario is an older homeowner who plans to use the rental payments and subsequent mortgage payments as retirement income.

From the buyer's point of view, obtaining mortgage financing is harder today than it's ever been. For a buyer who has a poor credit history or no credit at all, the lease-to-own option represents the opportunity to build good credit and own a home at the same time. Regardless of whether you are the buyer or seller in this transaction, the lease-to-own arrangement has its advantages and disadvantages that must be considered.

Lease-to-Own from the Buyer's Perspective

There are several advantages to the buyer under a lease-to-own arrangement. As previously stated, the most obvious among them is the ability to purchase a home without having to obtain bank financing up front. It is a great way to build or establish credit while at the same time getting out of the apartment environment.

The buyer also has an advantage in some cases when it comes to the purchase price of a home. In an area where real estate values are increasing, he is able to lock in a purchase price at the start of the contract. Even if a real estate values increase over the term of his lease, the purchase price he pays is the price agreed to when the contract was originally drawn up. In other words, if his lease runs three years, and real estate values climb over that three year period, the price he agreed to pay at the beginning of the term will be the sale price of the house.

One of the biggest disadvantages to the renter in a lease-to-own arrangement is that in all likelihood, the costs of maintenance and repair on the house will now fall on him. In a standard lease arrangement, fixing a leaky roof or replacing a furnace is the financial obligation of the landlord. But in a lease-to-own scenario, that financial burden falls on the buyer. If all things work out as planned, and the buyer does indeed purchase the home at the end of the lease term, he has lost nothing. But if things change and he decides to walk away from the house, any money he's put in to the residence is essentially lost.

Lease-to-Own from the Seller's Perspective

The biggest advantage to the seller in a lease-to-own arrangement is a broader scope of potential buyers for the property. This could be helpful in a down housing market where supply outpaces demand. By agreeing to a lease-to-own option homeowners make their property available to buyers who would otherwise not have access through traditional purchase and financing. Secondly, as previously mentioned, the lease-to-own arrangement gets the homeowner out from underneath the burden of any mortgage on the property. In a situation where a homeowner has bought the second house without being able to sell the first house, rental payments cover the mortgage on his first house.

Disadvantages for the seller are far greater in number than those for the buyer. First and foremost is the previously mentioned principle of the price lock at the time of the contract. Where the buyer gains the advantage with rising real estate values, the seller is at a distinct disadvantage. Once the lease-to-own agreement is signed, the seller is obligated to honor the purchase price at the end of the term.

Another disadvantage to the seller is the possibility of property damage by the buyer during the lease term. While lease-to-own buyers typically tend to be much better caretakers of the property, this is not always the case. If the buyer damages the house or property in some way and then walks away at the end of the lease, the homeowner may be stuck with costly repairs.

The Basic Outline of How Lease-to-Own Works

In a lease-to-own agreement both parties sign a contract which stipulates the buyer will rent the property from the owner for a given amount of time, usually one to three years. At the end of the lease term the buyer can choose to purchase the house or walk away.

The standard contract will have the buyer paying a certain amount of rent which is slightly higher than would normally be charged for that house on the local rental market. For example, if the sale price of the house was set at $150,000, and the current rental market dictates a lease payment of $800 per month, the buyer may pay $1,000 per month in rent. Of that payment, $800 goes to the homeowner as rental payments while the other $200 is credited towards the down payment of the house. At $200 per month on a three year lease, the buyer will have an accrued $7,200 towards the down payment.

The buyer will also agree to pay a lease-to-own fee that's generally at least several thousand dollars. For example, the contract may call for a lease-to-own fee of $7,600. Combining that fee with the $7,400 earned through rental payments means the buyer would have contributed a total of $15,000 toward the down payment by the time the lease term ends.

For the buyer, the advantage of this type of arrangement is the fact that he is essentially forced to “save up” for his down payment. This makes it easier for him to get a mortgage at the time of purchase. The disadvantage here is that if he decides to walk away, he loses the down payment credit as well as the lease-to-own fee. The homeowner gains should the buyer walk away, as he gets to keep all of that money.

Whether or not lease-to-own is a good option for you depends on your financial circumstances and your need to be in a house of your own. In the long run, a successful lease-to-own arrangement will cost the buyer more money than he would spend through traditional financing. But that may be a price you're willing to pay if your current financial situation does not allow you to purchase outright.

On the other hand, if you don't need the space of a home in the short term and can continue to rent an apartment, it may be better for you to set money aside for your down payment and attempt a traditional purchase in a few years. An experienced real estate broker or financial adviser should be able to guide you through the process of making the best decision.