To Lease, Own, Or Lease-To-Own Your Home?

By: Lance T. Denha, Esq.

At some time in your life, you may have rented a home or an apartment, so you may have undoubtedly encountered a lease agreement. If you’ve ever bought or sold a house, you’re familiar with a purchase offer. The lease-to-own agreement is a hybrid of the two – a lease agreement combined with a purchase offer. Whether renting is better than buying depends on many factors, particularly how fast prices and rents rise and how long one intends to stay in the home.

A lease-to-own house purchase (also “rent-to-own purchase” or “lease purchase”) is a lease combined with an option to purchase the property within a specified period, usually 3 years or less, at an agreed-upon price. The borrower pays an option fee, which is credited towards the purchase price. The borrower pays rent, and an additional rent premium that is also credited to the purchase price. If the purchase option is not exercised, the buyer loses both the option fee and the rent premium.

The sale price of the house and the rent are typically market based, however it is always subject to negotiation just as is typical in a straight purchase or rental transaction. Historical data shows that buyers are typically less knowledgeable of the market than are sellers which place the buyers at a disadvantage. Therefore it is always beneficial to have all parties, especially buyers, remain diligent throughout the process by seeking out independent, professional advice. Additionally, in these type of transactions, Buyers prefer lengthier option periods as they provide more time to build equity and repair credit whereas Sellers generally prefer a shorter option period so they can realize a more immediate return.

The option fee and rent premium are viewed differently by buyers and sellers. To the buyer, the option fee and rent premium are part of the equity in the house they will soon own. Fully anticipating that they will exercise the option, the only cost is the interest they would otherwise have earned. To sellers, however, these payments are the best guarantee that their houses will sell; if they don’t sell, the payments are retained as income.

Another possible alternative to a lease/purchase deal for consumers with poor credit and/or no cash is a sub-prime loan. Sub-prime loans continue to be available at reasonable prices from community groups or state and local finance agencies. Borrowers have to search out these sources, but if they can qualify for a loan from one of these sources, it is probably a better route than a lease/purchase.

The lease/purchase offers home ownership opportunities to consumers who can’t qualify for a loan from any source, but who are prepared to bet on themselves. The aim and goal for these borrowers is that before the option period expires, they will qualify for the mortgage they need to exercise the purchase option. During the option period, they have the opportunity to rebuild their credit and accumulate equity while living in the house.

It should be noted that consumers who need to rebuild their credit rating during the option period should understand that paying their rent on time will not accomplish this goal. Rent payment information is not used in compiling credit scores. Therefore, lease/purchase buyers who need a higher credit score must focus on their timely payments toward credit cards and other loans.

Leasing to own has advantages and disadvantages for both parties. The benefit to sellers may arise in circumstances where they currently have two homes and by utilizing the lease-to-own method, the seller will no longer have the obligation to come out of pocket for two mortgages during the lease term. As for buyers who can’t yet afford a house, the lease-to-own arrangement may be the best alternative in an effort to ultimately obtain title and a homestead in the fastest possible fashion.

As with any kind of financial contract involving residential real estate, both buyer and seller should be actively seeking competent professional advice from a team of professionals which may include an attorney, title agents (to ensure clean title), as well as real estate brokers, in order to find the best home suitable from a geographical and economical standpoint.