Simple Mortgage Definitions: Rent-To-Own / Lease Option

Gina Freeman
Gina Freeman
The Mortgage Reports Contributor
November 16, 2016 - 4 min read

Rent A Home Today, Own That Home Tomorrow

What do you do when you want to buy a home right now but can’t get approved, or don’t have the downpayment?

Consider rent-to-own, a less-common path to homeownership.

Sometimes known as the lease option, rent-to-own lets you make payments on a home month-after-month until such time as you’re ready to buy it.

Rent-to-own can be good idea when you ; or when your credit history is in “repair mode” — temporary conditions which you plan to soon correct.

Rent-to-own can help you land your dream home, but to pull it off, you’ll want to make sure your contract is sound and you’ve done your research appropriately.

If you plan to use a lease option on your next home, you’ll want to know a few things first.

What Is A Lease Option?

In real estate, a lease option is a hybrid contract between buyer and seller.

It’s part-rental agreement, part-purchase agreement, whereby the buyer agrees to rent a home for some period of time with the option to purchase the same home at some future date, at a previously agreed-upon price.

A sound lease option contract will define each of the following:

  • Purchase price: The price at which you can buy the home in the future
  • Lease length: The number of months for which the contract is valid
  • Option fee: An upfront payment to the seller, which is credited toward the future purchase price
  • Rent credit: A fee paid to the seller monthly, which is credited toward the future purchase price

The contract will also define lease provisions, which includes rules and noise and pets; and stipulations about when the rent is due.

In general, in exchange for a lease option, a home seller will assess a sizable option fee to be paid at the start of the contract, an above-market rental rate for the home, or both.

Then, once the lease period is completed as agreed, the monies paid get credited toward your downpayment as the buyer.

Where Can A Lease Option Go Bad?

When you rent-to-own, you’re entering into a longer-term agreement with a seller which gives you the right to purchase the home at some later date.

However, if the terms of the agreement are breached before that “later date” arrives, the whole thing is null and void.

For this reason, it’s important to understand the language of your lease option; and, to follow its terms to the letter.

First, you’ll want to avoid mistakes — which happen.

Suppose, for example, since signing your rent-to-own contract, you’ve built up $10,000 in credit toward your home’s purchase price of $200,000, — a five percent downpayment.

Your five percent downpayment leaves you with a 95% loan-to-value (LTV), which is more than enough to qualify for today’s .

However, if the seller wrote your lease option contract incorrectly, your rent credit may be credited against the the home’s purchase price instead of its downpayment.

This is significant.

Rather than having a five percent downpayment on your home, you’ll be given a five percent off the purchase price of the home instead.

To make sure your rent credit is eligible for use as a down payment, then, have the seller set rent above the property’s fair market rental rate.

A licensed appraiser can help you determine how much this should be.

Also, maintain meticulous records of your rental payment history. You may need it for your credit ratings and it’s unwise to rely on the seller to keep such records for you.

In addition, with your lease option, you’ll want to avoid particularly onerous terms. This is because any breach can nullify the contract, and cancel your option to purchase the home at a later date.

Treat Your Lease Option Like A Purchase (Because It Is)

Because lease option contracts don’t typically involve mortgage lenders; and because they can spark an informal tone between buyer and seller, it can be tempting to forgo the legal representation.

Don’t. Lease options are brought with risk, but risk which can be managed.

You’ll want to hire an attorney.

For example, an attorney can review your agreement with the seller, look for clauses which may cancel your option fee, or your right to purchase the home.

An attorney can also look at county records to make sure that the home you’re planning to purchase is not in foreclosure or — worse — owned by somebody other than the seller.

You’re likely purchasing the largest asset you’ve owned in your life. Spending a few hundred dollars on an attorney to protect your interests will be an excellent investment in your future.

There are other steps you can take to protect your interests in a lease options, too:

  • Ask a mortgage lender to review your lease option contract. You’ll want to make sure rent credits can be applied toward a down payment.
  • Hire a home inspector to review the home’s structure and the expected lifespan of its appliances and roofing.
  • Hire a title company to keep your option fee and rent credits in escrow.

You should also make sure that your lease option is recorded with the County Recorder.

This will prevent the seller from transferring the property while it’s under contract to you; and will prevent the seller from additional mortgages without your knowledge.

What Are Today’s Mortgage Rates?

Rent-to-own contracts can be a terrific way to purchase a home if you’re otherwise ineligible for a mortgage. However, you can’t know if you’re ineligible until you’ve applied.

Get today’s live mortgage rates now. Your social security number is not required to get started, and all quotes come with access to your live mortgage credit scores.

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