What you need to know before you decide to enter a lease-to-own agreement.
If you’re a cash-challenged home buyer, a lease-to-own agreement may be a way to buy a home and accumulate a down payment. A lease-option also gives you a chance to check out the neighborhood and occupy the home before you decide whether you want to buy it.
What is a lease-to-own or lease-option agreement?
A lease-option agreement is both a lease that allows you to occupy the home and an option that allows you to purchase the home in the future at an agreed-upon price.
A typical lease-option agreement requires you to pay a somewhat higher monthly rent for the home and obligates the owner to credit a portion of that rent toward your down payment. For example, if the owner’s expected market rent were $1,500 per month, he or she might increase that to $1,800 per month and apply $300 per month to your down payment. After one year, you would have a down payment credit of $3,600.
A formal contract is a must
A lease-option agreement should be formalized in a written contract that specifies the monthly rent, the amount of rent that will be credited to the down payment, the sales price and the expiration date of the option. Any contingencies (e.g., your right to obtain a home inspection) or other important terms of the agreement should be stated in the contract as well.
A lease-option allows the owner to sell the home to you without paying a commission to a real estate broker. But keep in mind that the transaction is thus bereft of a broker’s advice, expertise and assistance. Payment of other closing costs such as title insurance and transfer fees is subject to negotiation and should be addressed in either the lease-option contract or a later addendum to that contract.
Lease-option isn’t an obligation to buy
A lease-option doesn’t obligate you to purchase the home; rather, it is simply an opportunity to do so with the advantages of a known purchase price and a rent credit toward the down payment. If you elect not to exercise the option to purchase the home, your credited rent usually is forfeited to the owner. This money is a form of compensation to the owner for the option, which compromises his or her freedom to sell the property to someone else during that time. Reasons why you might decide not to exercise an option include lower property values in the area, an inability to obtain a mortgage, a job transfer or disenchantment with the neighborhood or the home, among others.
Who pays taxes, insurance, repairs?
The owner is responsible for property taxes, insurance, and repairs and maintenance of the property during the lease-option term since you have no ownership interest in the property. Likewise, the owner, not you, would suffer a loss if the property were damaged or destroyed by a natural disaster that occurred during your lease-option term. Nonetheless, you may want to purchase separate renter’s insurance to cover your own personal belongings. Of course, once you purchase the property at the end of the lease-option term, you’ll be responsible for the taxes, insurance, and repairs related to the home.
Because lease-to-own agreements can be complex legal arrangements, we recommend you contact an attorney to make sure your interests are protected.