NEW YORK (MainStreet) – Rent-to-own deals have an unseemly image, conjuring up thoughts of overpriced TVs and living room sets. But they can actually prove useful in today’s troubled housing market, allowing buyers and sellers to lock in deals until conditions improve.
Consider, for example, a buyer who has to move for a new job but can’t buy a new home until the old one sells, or the buyer who needs a little time to repair his credit or wait for his spouse to land a job. With a lease-to-own deal, also called a lease-purchase agreement, any of these buyers could nail down a dream home that’s available today, perhaps at a better price than in a year or two. That can take the sting out of renting.
Sellers can benefit as well. Instead of leaving a home empty, the owner can bring in a tenant to cover expenses, something that can be hard to do if a home is up for sale. The owner thus doesn’t have to give in and sell while prices are down and buyers are scarce.
Still, a lease-to-own is not to be taken lightly. Both parties are gambling on future conditions such as home prices and mortgage rates, and their bets could backfire.
While all lease-purchase agreements are negotiable, they tend to follow a basic blueprint: Seller and buyer agree on a sale price for the property, with the buyer given a specific period to exercise the purchase option, typically one to three years.
In exchange, the buyer pays a one-time option fee, typically from 1% to 5% of the sales price. The buyer pays rent plus a rent premium that, like the option fee, compensates the seller for keeping the home available.
If the buyer exercises the purchase option, the option fee and rent premium will typically be applied against the sale price. If the option is not exercised before the deadline, the seller keeps the fees and can find another buyer.
In a typical deal, the sales price would be higher than the owner could get today, but perhaps lower than the buyer would expect to pay in a year or two. Obviously, a large miscalculation can be very costly to either party.
As a rule, buyers prefer long option periods, giving them time to accumulate down-payment funds, repair credit, unload another home or land a job. But the longer the period, the more the buyer will lose through the monthly rent premium if the sale falls through.
Sellers generally want the option period as short as possible to get at their equity sooner. But making it too short will make it too difficult for the buyer to get in a position to buy.
The parties must also hammer out the fine print. What would happen, for example, if the buyer failed to make rent payments on time? Would the option fee and rent premium be forfeited? What if the owner failed to maintain the property, or to keep up with real estate taxes or insurance premiums?
And of course, both sides must agree on all the usual issues involved in a lease, such as the handling of deposits, responsibilities for routine maintenance, and rules on who may live in the property.
The issues in a lease-purchase agreement are complex, and often neither party has much experience in this area. So, a final tip for all involved: Hire a good real estate lawyer.
For more tips on buying, selling or renting a home, check out MainStreet’s Real Estate topic page!