Lease to Own Option and its Pros and Cons for Buyers and Sellers

A lease to own option is a good idea if you need more time to save up for the purchase. Know its pros and cons and whether it is right for you.

One of the most significant issues for real estate owners is a stagnating property. It refers to a property not selling at the owner’s asking price. Several factors contribute to this, such as a high asking price, low demand, or an unstable economy. Fortunately, a solution exists to benefit both owners and buyers: lease to own. 

Table of Contents

1. What Is Lease to Own? 
2. What Are Rent to Own Homes? 
3. Pros and Cons of Lease to Own 
4. How to Spot Potential Lease to Own Scams
5. Tips to Rent to Own a Home
6. Who Rent to Own Arrangements Are Best for

Lease to own provides property owners with an opportunity to generate income by renting out their property to prospective buyers. It also offers tenants the ability to lease a property with the potential to become its owner after a specific period of time. 

This process proves advantageous for individuals aiming to achieve homeownership. It is best for those with limited funds who require additional time to accumulate savings for a down payment.

The idea is simple: If the interested buyers are still saving for the home purchase, the owner allows them to rent it first. It is a lease with option to buy the house after a certain period. This process gives you the best of both worlds. You don’t need to purchase the home immediately if you can’t afford it yet, but you’ll own it eventually.

A lease to own option is a legitimate way to acquire a home. Note, however, the risks you should be aware of.

Related: Where to Find the Most Profitable Rental Properties in the USA

What Is Lease to Own?

Lease to own is an arrangement in which a person has the opportunity to purchase a property after initially leasing it for a specific duration. It is an alternative option for individuals lacking the immediate funds to buy the property. It’s also a good option for those who may not yet meet the requirements for traditional financing. 

By entering into a lease to own agreement, individuals can buy themselves some time to raise the necessary funds. It also gives you time to secure mortgage approval.

With a rent to own agreement, the tenant typically pays a higher rent than they would for a traditional lease. It is because a portion of that rent is applied toward purchasing the house. At the end of the lease term, the tenant has the option to buy the house. 

So, how does rent to own work? In order to understand the process, you have to know the two major types of rent to own contracts: lease option and lease purchase.

What Is a Lease Option Agreement and How It Works

With a lease option contract, the property owner gives tenants the option to buy the home at the end of the lease. It is only an “option,” meaning you are not obliged to purchase the property after the lease expires. The best thing about a lease option to buy is that it gives you the right to buy the house if you want to. 

With a lease option agreement, you need to pay an option fee ranging from 2% to 7% of the purchase price. It is typically a one-time fee that gives you the right to buy the home at a later date, usually after the lease expires. Usually, the option fee will be applied toward the purchase price. You’ll need an appraisal to determine the fair purchase price at the end of the lease. 

In addition to the option fee, you need to pay a slightly higher rent compared to a regular lease. The difference will be applied to your rent credits. These will go toward your down payment at the end of the lease term if you decide to buy the property. 

The good news is that you are not obligated to purchase the home after the end of the lease. In fact, you can simply walk away from the “rent with option to buy” deal if you choose not to proceed with the purchase. The catch, however, is that you will forfeit your rent credits and option fee. 

What Is a Lease Purchase Agreement and How it Works

A lease purchase contract is another type of rent to own agreement that also works in almost the same way as the lease option agreement. You lease the house for a certain period. You need to pay rent that is higher than usual because a portion of it goes toward your future down payment. The only difference is that you have the obligation to purchase the house.

When you enter a lease purchase agreement, you and the seller should agree on the purchase price. It’s best to get the home inspected and appraised to ensure a fair price. It will give you sufficient time to secure funding for the purchase at the end of the lease term. 

If you choose this type of lease to own agreement, you need to start applying for a mortgage. It ensures that you have a financing option after the lease expires. If you cannot get a loan to fund the purchase, or if you decide not to buy the property, you’ll lose your rent credits. In addition, you also run the risk of getting sued by the seller for a breach of contract.

Lease Option vs Lease Purchase: Which Is Better?

The better type of rent to own contract depends on your financial availability and personal plans. If you want to buy a house but are not sure whether or not you can come up with enough funding, it’s best to look for a lease option to buy homes. 

Although this type of lease to own agreement charges an option fee, at least you’re not tied into the contract. You don’t have the legal obligation to proceed with the purchase if your circumstances wouldn’t allow it. Plus, you can even stop renting the property at the end of the lease term if you choose to. 

The only downside to this is losing your option fee, rent credits, and the right to buy the house before it gets listed on the market.

On the other hand, if you are sure to buy the property at the specified period, it’s best to consider entering into a lease purchase agreement. It will save you from paying the option fee. What’s more, you can lock down the price for the home at the start of the lease. This means that even though the market appreciates, you won’t risk getting an increased price.

What Are Rent to Own Homes?

Rent to own homes are residential properties listed under rent with option to buy programs. These are the houses that, when rented out, the rental agreement includes a clause that gives you either the option or the obligation to buy the home after a predetermined period.

When renting the lease with option to buy homes, you make rent payments each month that are higher than the typical rent. It is because a portion of that rent will go toward your future down payment. After the lease expires and you decide to buy, the rent credits you earned will be applied to the purchase price. 

One of the benefits of lease to own homes is that it gives you the chance at homeownership without having to spend a large sum of money upfront. It is a great alternative for those who cannot pay for a substantial down payment right away. This is also designed for those who need time to improve their credit so they can find a mortgage lender to approve their loan.

Pros and Cons of Lease to Own

Like any financial arrangement, rent to own homes have their advantages and disadvantages to both sellers and buyers. It’s important to understand the pros and cons first and see if the benefits outweigh the drawbacks. Whether you’re a buyer or a seller, understanding the advantages and risks is crucial before you decide if this process is right for you.

Here are the rent to own pros and cons for sellers:

Benefits to Sellers

For sellers, listing their property for lease to own is a great way to sell it. Sellers can earn income from rent while waiting for the buyer to finally purchase the property. This is ideal if the seller is not in a hurry to sell your house. 

Here are the benefits for sellers if they list their property for lease to own:

Competitive Edge

A lease option strategy is an excellent investment strategy in a highly competitive market. If plenty of sellers are competing for buyers, the seller who offers the house for rent to own will have a competitive advantage.

Monthly Income

If the seller cannot sell the house at that moment, then a lease to own agreement will provide a financial opportunity. Instead of just waiting for a buyer to buy the house, the seller will earn a monthly income through rent payments. There is also a possibility that the tenant will buy the home after the lease expires.

Extra Fees

With a lease option to buy, sellers can charge an option fee and additional rent premium, which they can forfeit should the buyers change their minds. Sellers should know how to structure a lease option to buy agreement. It should clearly state that the renters cannot get back their option fee and rent credits should they decide not to buy the house.

Better Property Upkeep and Maintenance

Unlike regular rentals, a lease to own tenant is more likely to maintain the conditions of the property because of their option to purchase it eventually. It allows the seller to save some money in repairs and maintenance costs over the years.

Drawbacks to Sellers

If there are benefits to listing the house for lease to own for the sellers, there are also drawbacks. Sellers should understand the risks involved and see if the benefits outweigh the cons. 

Here are a few downsides of rent to own transactions for the sellers:

No Huge Sum of Money Upfront

If the seller is in need of a more significant amount of cash, then a lease to own transaction won’t help with that. A lease to own functions on rental price ranges for several years, and that deprives the sellers of their goals.

Risk of Depreciating Property

If the buyer decides to exercise their option not to buy, then the seller will be forced to perform repairs and maintenance on the property. Otherwise, the seller will have to sell the same property for a lower price than its original value because of property depreciation. 

Uncertainty

The most haunting disadvantage for the seller in lease to own agreements is the uncertainty that comes with it. Lease options are usually long-term contracts that last for years. If the buyer decides not to purchase, the seller must go through the same cycle again. This consumes a lot of time, energy, and money.

If lease to own transactions have benefits and drawbacks for the sellers, they also have advantages and disadvantages for the buyers. Here are the pros and cons of rent to own agreements for buyers:

Advantages to Buyers

A lease to own transaction is better for buyers who cannot buy a house using the traditional home-buying process. Here are a few advantages:

Interest-Free Financing

In a way, a rent to own transaction allows you to pay your down payment in installments without interest. It is better than taking out a loan for your down payment. That is why rent to own is more favorable to buyers who need money for a down payment.

Chance to Buy Time

A lease to own is an exciting prospect for someone short on cash and unable to qualify for a mortgage. It gives the buyers time to save for the rest of the down payment or improve their credit ratings for a mortgage before the purchase date.

Also, it’s a good option if you are relocating and waiting to sell your own property to fund the purchase of a new one. You’ll have the opportunity to get settled in at your future home until you can purchase ultimately.

Pre-Agreed Purchase Price

A purchase price for the property is usually agreed upon at the signing of the agreement. It is a huge advantage for the buyer. You can avoid additional costs if the property appreciates after several years of renting.

Investment Opportunity

A lease to own can act as a trial period for the buyer. If the buyers are new in town or relocating, a lease to own allows them to test this neighborhood as an investment opportunity.

Chance at Homeownership

With a rent to own arrangement, you are not just throwing your money away to rent. It’s an achievement to have a portion of your monthly rent payments go toward purchasing the property.

Downsides for Buyers

While there are advantages to a lease to own arrangement, buyers should also be aware of the potential risks involved. Here are a few disadvantages of rent to own that you have to know before you decide whether this homeownership option is right for you:

You’re Still a Tenant Until the Purchase Fully Materialize

A lease to own does not make the buyer an owner of that property. It will still belong to the seller, providing them full control over the property. It might be a minor issue, but for the buyer, it will feel like being a tenant and not a homeowner.

There’s a Risk That the Purchase Will Not Push Through

The plan might not work out because you might be unable to improve your credit rating or save up for a down payment. It will result in losing out on the property you planned to purchase. Not only that, but you will lose your rent credits and option fee too.

You Risk Losing Cash

Sellers ask for a one-time option fee to be paid in return for the buyers’ optional decision on purchasing or not. The fee varies depending on the seller, but if the buyer refuses to buy, then they lose that fee to the seller.

Higher Monthly Costs

Only a portion of your rental payments will go toward the purchase price, so rent to own buyers usually pay more than the home value. Also, since you already agreed on the price, you’ll end up paying more than what the house is worth if the home value plunges.

How to Spot Potential Lease to Own Scams

Most homes listed under rent with option to buy programs are legit. However, there are many fraudulent listings too. In fact, many scammers use lease to own transactions to prey on people. 

Some scammers list a property that they don’t own. They will meet with the interested buyer and pressure them to pay a deposit or option fee. After receiving the money, they can no longer be reached. 

As a buyer, it’s essential to perform due diligence first before you pay anything. Don’t rush into things and ensure everything is legit before closing a deal. Here are a few ways to spot a potential scam:

1. Know the Average Market Rents

If the rent is too good to be true, then it most likely is. Anything below the average market rent value is suspicious, especially with lease to own arrangements. After all, you need to pay extra for a lease to own house for your rent credits.

2. Verify the Ownership of the Property

Check the title of the property to ensure that the seller really owns it. Ensure that the mortgage payments and taxes are updated. Check the title to ensure it is free from liens or lis pendens. 

3. Don’t Pay Anything Right Away

If the seller is trying to pressure you and asking for money to “reserve” the property for you, it is a flashing red flag that it might be a scam. Don’t pay anything until you have done inspecting the property and performing due diligence.

4. Don’t Skip the Home Inspection

Another form of scam is selling you a property with a lot of undisclosed structural defects. Make sure to conduct a thorough home inspection. Hire a professional contractor to inspect the property so you’ll know what you are buying.

Tips to Rent to Own a Home

Before you sign a lease to own contract, make sure that you understand the provisions of the agreement. When in doubt, it’s best to work with a real estate attorney to help you navigate the process. 

Here are a few tips to keep in mind:

Tip #1: Choose the Right Rent to Own Contract

Choose a type of rent to own agreement that would work best for you. If you cannot commit to the purchase and are willing to pay (and potentially forfeit) the option fee, a lease option contract is better. But if you’re 100% certain to buy the property after a predefined period, then it’s best to go for the lease purchase agreement.

Tip #2: Perform Due Diligence

Research the home, its history, ownership, and outstanding mortgage. Ensure that it is legit and the seller really owns it or has the right to sell it. Moreover, perform an independent home inspection and appraisal to verify the value of the property. You don’t want to pay more than the home value just because you failed to conduct an appraisal.

Tip #3: Understand the Terms of the Lease to Own Contract

Read the terms and conditions of the contract carefully and ensure that you understand every provision. If there is anything that is not clear to you, make sure to ask the seller to explain it. A few things that you should be aware of are the following:

• How much is the option fee (for lease option agreements)
• How much is the purchase price (for lease purchase agreements)
• What is due when
• How much is the rent
• What percentage of the rent will go to rent credits
• How much is the security deposit, and whether or not this will go toward your down payment at the end of the lease term
• What are the penalties if you decide not to push through with the purchase (for both lease option and lease purchase agreements)
• Who is responsible for maintenance during the lease period
• For lease option contracts, find out how to exercise your option to buy the house at the end of the lease term
• Other information that you think you should know

Tip #4: Hire a Professional

When in doubt, the best thing to do is work with a real estate professional to ensure everything is in order. A real estate attorney can help you understand the terms of the lease to own contract and perform due diligence on the property. You should also hire a professional contractor to perform the home inspection.

Who Rent to Own Arrangements Are Best for

In general, rent to own arrangements are ideal for those who want to buy a house but don’t have enough money to pay the down payment. If you’re not sure if rent to own is right for you, consider the following:

When to Consider Lease to Own?

A lease to own is an excellent option if:

1. You Need Time to Save for a Down Payment.

When you buy a house, you need to shell out a considerable amount of cash for a down payment. It is usually 20% of the selling price or more. If you don’t have this much, a rent to own arrangement is a great idea because you can save through paying rent premiums. These rent credits will eventually go to your future down payment.

2. You Need to Improve Your Credit Score.

To qualify for a loan, you need a good to excellent credit score, depending on the mortgage lender. If your credit score is poor or below average, you can buy time to improve your credit before you apply for a mortgage with a rent to own arrangement.

3. You Don’t Have the Self-Discipline to Save.

If you don’t think you can save for a down payment on your own, a lease to own agreement forces you to pay a premium that will go to your down payment. It is a great way to help you toward home ownership.

4. You’re Sure of the Neighborhood.

If you’re sure you want to live in the area where the rent to own house is, renting the property to own it eventually is a good idea. Make sure to assess the location to ensure that it’s safe and has the potential to grow. One great way to evaluate the neighborhood is by using Mashvisor’s Market Finder.

What Is Market Finder and How It Works

Mashvsior’s Market Finder is a feature that lets you find the best neighborhoods in your chosen city. If you want to find the safest areas, you can filter the search results by Crime Rate. You can also look for the neighborhood directly on the search bar to check its metrics. 

Aside from its crime rate, you’ll also find other important information. You’ll have access to the median price, which can help you determine if the purchase price set by the seller is fair enough. You’ll also see the average rent for long term rentals. It can help you decide if the rental rate of the seller is not too much over or under the market average. 

Related: Invest in Long-Term Rental Properties: A Secure Investment Option

Other information found on this page can help you determine the potential profitability of the neighborhood. It is a great way to decide if the place is a good location for investing in real estate or not.

Want to know more about Mashvisor and its tools? Start a 7-day free trial now.

When Not to Consider Lease to Own?

A lease to own transaction will not work for you if:

1. You’re Not Sure You Can Get Approved for a Mortgage

Unless you have a large sum of money arriving by the end of the lease to buy the house in cash, you need to get a mortgage to fund the purchase. If you’re not sure you can get approved for a loan, it’s best not to commit to a lease to own agreement. However, if you don’t push through, you’ll end up losing more money.

Related: 6 Best Companies Offering STR Loans

2. You Can’t Pay Your Rent on Time

In most cases, the rental rates for lease to own transactions are higher than the regular rent. If you can’t pay your rent on time, you risk harming your credit score more. What’s more, there are rent to own contracts that stipulate you lose your rent credit if you make a late payment. 

3. You Don’t Have an Action Plan to Improve Your Credit Score

A lease to own program gives you time to improve your credit score. But you need to have a proper plan in place to do this. If you don’t, then you might not be able to achieve the credit score required to get a loan, which will result in not pursuing the purchase.

4. The Neighborhood Is Not a Suitable Location for You

If, after checking the place, you discover that the neighborhood is not an optimal place to live in, it’s best not to settle for less. When you sign a rent to own lease, it’s like buying a home. Unlike renting a property, this is not only temporary. If you don’t like the neighborhood, then a lease to own arrangement should not be pursued. 

Bottom Line

A lease to own agreement is an investment strategy that gives more power and freedom to a buyer. Sellers are usually forced into lease options because of their inability to sell their properties at the time. Buyers, on the other hand, can enjoy the extra time they have to save money and build credit before buying the property.

Make sure to understand the pros and cons of this arrangement for both buyers and sellers. If a potential buyer can get their hands on a lease to own agreement, it would be advantageous as long as they ensure the transaction is legit.

As a buyer, you need to be sure of the place first before you commit to buying the property. Mashvisor can easily help you with this.

Want to know how Mashvisor works? Schedule a demo today.