If you’re dreaming of homeownership but don’t quite have the down payment or credit profile to make it a reality, a lease-purchase option is one of several avenues to consider..
What is a lease-purchase?
A lease-purchase is a contract in which a landlord and tenant agree that, at the end of a specified period, the renter can buy the property. The tenant pays an up-front option fee and an additional amount each month that goes toward the eventual down payment. If you decide not to purchase the home at the end of the agreement, you could lose your option fee as well as any money you put toward a down payment, but a seller can’t come after you for opting not to follow through with the purchase. This is why it is extremely important to read the contract and have a real estate attorney review it.
Lease-purchase contracts go by other names, including:
- Rent-to-own agreements
- Lease-to-buy option
- Rent-to-buy option
Lease-Purchase contracts can be complicated, so make sure you’ve addressed the following questions before moving forward:
1. Structuring the deal
It should go without saying that you must fully understand all of the terms of the contract, especially the term (length) usually 3 to 5 years and the amount of the option fee, which can be any amount that is mutually agreed and typically varies from a few hundred dollars to 20 percent of the value of the home. Also, how much is going toward the rent and how much toward the future down payment. One big caution is to watch out for a contract in which you lose your option money and all your paid-in capital toward the down payment if you fail to purchase the home or property.
Typically, you’ll pay above-market rent, with an additional amount, also to be mutually agreed, going toward a future down payment on the property. It would be wise to negotiate a ‘rent freeze’ while you are working toward the purchase of the property. You’ll really want to consult a real estate attorney who has experience with these agreements to look over the contract before you sign it.
2. How to prepare for the purchase
It is very important to talk to a lender before entering into the lease-option-to-buy agreement to make sure that they’ll credit the money you’ve paid to the homeowner on top of your rent payments toward your purchase. This way, you’ll know how much money you’ll need to cover a down payment and closing costs later on.
Also, talk to the lender every few months and stay informed of the mortgage market, changes in credit qualifications, debt-to-income ratios and other changes in the qualification requirements that could affect your ability to purchase the home.
3. Improve your credit
In addition to amassing a down payment, use your time renting to improve your credit in order to qualify for the best possible rate when it’s time to buy the home. In other words, pay down your debt, avoid opening new credit accounts and pay all of your bills on time and avoid any large purchases, such as a new car, at least six months prior to expected purchase.
4. Identify the housing market in the area
You can either agree on a purchase price in advance or agree that the sale prices will be contingent on an appraisal at the time of sale. Home values may fluctuate during your lease period, so it’s important to know if the price can be adjusted before you buy. Just because they are on the rise now does not mean they will continue to rise for the next 3 to 5 years.
You should consult with an experienced and knowledgeable Realtor that can provide you, and the seller, with a Comparative Market Analysis (CMA) that takes into account a myriad of factors including what comparable homes in the neighborhood and near vicinity have sold for in the past 3 months or so.
In a market where home prices are going up, it can benefit the buyer to lock in a price in advance. But in a market where prices are falling, you may end up agreeing to pay more than the home will be worth at the time of purchase.
In that scenario, you might have a harder time getting approved for a mortgage or pulling together a sufficient down payment plus closing costs. There are many ways to structure this and we can discuss more options when you complete the Contact Us at the bottom of this page.
5. Who’s responsible for what?
The lease-option contract must spell out who’s responsible for the maintenance and repairs of the home, as well as who is going to pay for homeowners association fees and utilities. You’ll need to have renter’s insurance, and the owner is responsible for purchasing landlord’s insurance.
Also, don’t forget the bigger ticket items that come with home ownership such as replacing the roof or the air conditioning system which can easily run $5,000 or more to replace. A professional home inspection can guide you on what is the likely remaining useful life for some of these items that will help you negotiate the best terms.
6. Do I need a home inspection?
As with any home purchase, it’s critical to get a professional home inspection to ensure you’re making a sound investment. It will cost a few hundred dollars upfront, but it’s worth it to ensure a property doesn’t have major red flags. If the inspection report uncovers costly problems, you’ll want to work out when those repairs will take place and who’s going to pay for them.
This is another area where a professional Realtor can help a great deal and that is in the title search - to be sure there are no liens or other ‘clouds’ on the title that the seller would be responsible for removing. Also, your Realtor can check on any planned assessments with the local government or HOA to ensure you’re not caught off-guard by some major property assessment. See our website at Home Inspections for more information on home inspections and our Preferred Vendor List.