How Rent-to-Own Lease Agreements Benefit Both Tenants and Landlords

Rent-to-Own Lease Agreements: The Basics

Buying a home through traditional channels is the same whether you use a real estate agent or negotiate directly with the home owner. After the owner accepts your offer, your broker negotiates with lenders to find the best financing available to you based on your credit score, the amount of money you are able to use as a down payment, and other factors.

Once you sign the necessary paperwork, you become the official property owner, the title transfers to your name, and you are now responsible for both maintenance and the payment of property tax.

Likewise, renting a home usually follows the same basic format. You sign a lease agreement stipulating that you will pay your landlord a certain amount of money each month and abide by certain conditions set forth in this document, and the landlord generally pays for maintenance and holds a security deposit against any damages you cause while living in the property.

Rent-to-own lease agreements are a hybrid arrangement combining some aspects of new home purchase with a traditional lease agreement. Here are the main features of the agreement:

• Tenants pay an upfront fee and/or larger monthly rental payments in order to have an option to purchase – The rent-to-own option begins with a commitment from the tenant in the form of higher payments or an initial fee, or both. The landlord either deposits the extra money in an escrow account, awaiting the time when the tenant exercises the option to purchase, or the landlord takes a percentage of the extra money each month and applies it to the principal owed on the property. The second option allows a tenant to build equity in the home before they officially own it. In the case of the first option, the landlord refunds the escrow monies to the tenant at the time of purchase. In the eventuality that the tenant does not exercise the option to purchase, or they do not meet the terms of the lease agreement, they forfeit both the initial fee and any additional rent they paid.
• Tenants and landlords sign a lease agreement – Rent-to-own lease agreements start off looking a lot like standard leases because the eventual transfer of the property from landlord to tenant is contingent on two things: (1) the tenant's successful fulfillment of the lease agreement, and (2) the tenant exercising the option to purchase. Until that time, the home belongs to the landlord.
• The tenant must fulfill the terms of the lease agreement – If the lease prohibits pets or subletting to unauthorized guests, the tenant must comply with these regulations just the same way they would if this was a regular lease. Should the tenant fail to fulfill the terms of the lease agreement, they forfeit the extra money they have invested in the rent-to-own option.
• The tenant is responsible for maintenance – A big difference between rent-to-own lease agreements and a standard lease is who takes care of the maintenance. When you are renting to own a property, the presumption is that it will belong to you at some point. Thus, you are responsible for fixing problems as they arise.
• The title remains with the owner until the tenant exercises an option to purchase – In a typical home purchase, buyers get the title to the property as soon as they exchange money at closing. That is not the case in a rent-to-own lease agreement. Tenants do not own the house until they exercise the option to purchase. Moreover, they could jeopardize that option at any time for failure to fulfill the terms of the lease agreement.

Advantages to Landlords

There are a number of obvious benefits for landlords using rent-to-own lease options:

• The landlord avoids having to pay the agent commission associated with selling a home. Since these fees typically run six per cent of the home's selling price, that is a sizable saving.
• The landlord assumes very little risk in rent-to-own lease agreements. The regular terms of the lease must be fulfilled, so there is no increased risk from damage. The tenants must take care of maintenance themselves. Should the tenants fail to pay rent on time or violate other items in the lease agreement, they forfeit all of the extra payments they have made to the landlord.
• Rent-to-own lease agreements give landlords a way to liquidate properties in less than ideal market conditions. For instance, if the property is at the end of a busy commercial street, it would take much longer for that house to sell through conventional means. Other houses might need thousands of dollars invested in their curb appeal or basic infrastructure. In a rent-to-own lease situation, the tenant absorbs that responsibility, saving the landlord money, time, and aggravation.

Advantages to Tenants

Although more and more millennials are renting by choice, the fact remains that homeownership eludes millions of Americans because they lack the financial stability to purchase a home. For them, renting is not a deliberate strategy; it is a way of life, and an insecure one at that.

The primary advantage of entering a rent-to-own lease agreement is that it offers people a way to build credit and become a homeowner. In some cases, tenants are actually able to build equity in the home while they are still renting. Theoretically, making extra payments in rent gives tenants a greater stake in the property and can therefore encourage creditworthiness in the form of regular and timely rent payments.

At the same time, should a tenant's financial situation worsen, they are not obligated to exercise the option to purchase. They will forfeit any extra money they gave the landlord, but they do not have to face the potentially much more severe ordeal of going through a foreclosure.

What You Need to Know to Avoid Problems

Some Final Advice for Prospective Homeowners

Homeownership is a long game with many financial and psychological rewards. For most Americans, it is the primary means of building wealth, and this wealth can be leveraged in a number of ways, making it possible to send your children to college, to consolidate outstanding debt, and to provide you with a secure retirement.

People who choose rent-to-own lease agreements must keep their eyes firmly on that prize, recognizing that they are buying creditworthiness and have to pay a premium for that privilege. Even if the house you are renting to own is not your dream home, it can put you on the property ladder and bring you much closer to purchasing the home of your dreams.

Tenants interested in pursuing this option should think strategically about the long-term benefits for themselves and their families. Some questions you need to ask yourself are:

• Can I afford to make necessary repairs to this property before I am able to exercise the purchase option?
• Is the extra rent payment something I can afford?
• Am I either committed to living in this home or to transforming this home into a property that I can sell in a few years?
• Is this home in a location that makes resale difficult? Can I make improvements that will boost its salability?

Even houses in poor condition or less than optimal locations can make good investments. For instance, you can cash out the equity in such a home to afford the down payment on a house that better meets your needs, and then continue to rent out the first home to someone else.

Whatever you decide, your plans must include developing solid financial habits. If you can make the commitment and swing the extra expense, though, a rent-to-own lease agreement is a solid opportunity to stop paying rent and start building equity.