In the last several months I’ve seen a couple Rent to Own Agreements relating to homes which have gone seriously wrong. There are a lot of products that you can “rent to own” in addition to homes. Most rent to own agreements involve the purchase of furniture, electronics, cars and other high cost items.
A Lease Option is a type of rent to own agreement which relates to the purchase of a home. In these agreements a tenant usually agrees to lease the home at a higher price than they would normally rent the property. Often, the rent will be set aside and saved as part of a down payment and people are willing to pay above the market rate on rent because they believe they are essentially buying the house anyway. In this way the tenant, who usually has entered into this agreement because they don’t have good credit and cannot qualify for a regular mortgage, has time to build up their credit and save towards a down payment on a house. They also usually make what they consider a “down-payment” in order to enter into this lease option.
There are a few things that regularly go wrong (in the tenants’ mind) with these agreements and they relate to what happens if the renter/rent-to-owner defaults on the rent.
1. Say the renter has been paying an inflated amount of rent which will go to the down payment and they have defaulted on the rent and can no longer pay. Usually the agreement says that the renter loses the share of money that they have been paying in rent, even the inflated amount of rent the person paid to buy the home. Or put another way, the renter will not usually get the money that they have been over-paying back if they can no longer pay rent or decide to break a lease. So a renter has effectively put themselves into a situation where they have been overpaying for their home and they have signed a contract that says that if they default or break the contract they can’t get that money back.
2. Say the renter/buyer has put a bunch of work into the house based on the idea that they will own it some day and they want to make improvements now. Usually the agreement says that the renter has to pay for the work done on the house but they still have to get permission from the landlord/seller. In this type of agreement it is unlikely that a renter/buyer will get compensated for the work they have put into the house even if the renter/buyer decides not to buy the house.
3. Say the renter has put a down payment on the house and they default in the rent. Usually the lease option agreement says that if the renter defaults on the rent the landlord gets to keep the down payment. This is because according to an average rent to own/lease option contract the “down payment” is actually the money paid to the landlord in order to purchase the OPTION to purchase. If you end up exercising the option then, and only then, does the money to purchase the option get put towards the down payment on the home. Let me say this again: YOU ARE ONLY PURCHASING THE OPTION TO BUY THE HOUSE, YOU ARE NOT MAKING A DOWN PAYMENT ON THE HOUSE UNTIL YOU EXERCISE THE OPTION TO PURCHASE. Until you exercise the option the relationship you have with the seller is actually more like a landlord/tenant relationship. Be careful!
Lease Option Agreements are not all bad, they can be a way for someone who does not have good credit to buy a home. However, it is vital that you read through the entire document and understand it so that you know what is going to happen to the money that you are investing. If you do not understand the document then its important that you take steps to educate yourself before you sign the contract by talking to a lawyer. I know it can be expensive, but you will end up saving money in the long run if things don’t go as planned.