A rent to own contract is a contract between a property owner and a renter who plans to buy the property within a specified period of time. In most cases, the renter will pay the owner a deposit which will be used towards a down payment when it is time to purchase the house. In addition to the deposit, the owner will collect rent every month, a portion of which may be applied towards the purchase price.
The owner and potential purchaser negotiate the same contract of sale that is used in a regular house purchase, however instead of executing the contract, it becomes an exhibit to a lease agreement, whereby the buyer and seller become tenant and landlord. The lease agreement provides all the typical terms of a rental, including the monthly rent, security and term, but also provides that the tenant has the option to execute the attached contract at any time prior to a fixed date. The lease may also provide that if the tenant does exercise the option, a portion of the rent paid will be applied to the purchase price.
Benefits to Sellers
If an owner is having trouble selling, a rent-to-own relationship provides an alternative to lowering the purchase price or taking the house off the market. In addition the owner receives a monthly rental payment to offset the cost of owning the property (the mortgage, property taxes, insurance, etc.). Also, unlike a traditional rental agreement, the tenants are more likely to take care of the house because they have the option to purchase it.
Benefits to Buyers
A rent-to-own agreement may appeal to buyers who do not yet have the down payment or the monthly income to qualify for a mortgage. A lease option allows them to start making payments towards ownership right away. In addition, the owner may continue to pay for and complete any maintenance and repairs on the house. Finally, by living in the house before deciding to purchase it, a buyer has the advantage of “test driving” the house before making a major financial commitment.
Potential Pitfalls
As with all contractual relationships, the parties should be aware of the potential issues with a rent-to own contract. Before entering an agreement, the parties need to perform some due diligence.
- Get comfortable with the other party’s financials. As a landlord, getting a non-paying tenant removed from your home can be aggravating and expensive. As a potential buyer, you should be cognizant that, for a variety of financial reasons, a seller could lose the property during the rental period. If the seller loses the property, the potential buyer may lose the right to buy the property, forfeit the rent paid toward the purchase price and will have to find a new place to live.
- Parties may want to work with an experienced real estate broker to ensure that both the rental payments and the purchase price are fair.
- Both owner and potential purchaser may want to consult with a mortgage broker up front to ensure that the purchaser will have the ability to obtain a mortgage down the road.
- Property owners should confirm that renting the property does not violate the owner’s mortgage and that property insurance premiums will not increase.
- Potential purchasers should obtain a home inspection and a title report. An inspection can uncover potential structural issues with the property; a title report can provide information about taxes, liens and other encumbrances on the property.
It should be noted that an option to purchase real property combined with the right to use or occupy property has tax ramifications for both owner and renter. Parties should consult with their accountant regarding the potential tax consequences of a rent to own contract.