After years of moving from one home to another, a good number of tenants may want to transition from renting to settling down permanently. Somewhere along the way, they will begin to consider buying their own property.
When buying a home, there are a variety of options. Of course, the most popular route to take is to apply for a mortgage. However, some buyers may find difficulty qualifying for one, so sellers may offer them other alternatives. For instance, if a seller is working with a buyer who cannot obtain a traditional loan from a lender, they can opt to lease out the property under specific conditions.
A seller may offer potential buyers two types of leasing options: Lease-to-Own or Lease Purchase.
What’s the difference?
Lease-to-own and lease-purchase agreements are both types of arrangements that allow a tenant to rent a property with the option to buy it in the future. While they share some similarities, there are distinct differences between the two:
- Option to Buy:
- Lease-to-Own Agreement: In a lease-to-own agreement, the tenant has the option (but not the obligation) to buy the property at a predetermined price within a specific timeframe. The tenant pays an upfront option fee to secure this right. If the tenant chooses not to buy the property, they may lose the option fee but can simply walk away from the agreement without any further obligation to purchase the property.
- Lease Purchase Agreement: In a lease purchase agreement, the tenant is typically obligated to buy the property at the end of the lease term. Unlike the lease-to-own agreement, the tenant does not have the option to walk away without buying the property. Failure to purchase the property at the end of the lease term may result in legal consequences or forfeiture of certain amounts paid as part of the agreement.
- Rent Credits:
- Lease-to-Own Agreement: In some lease-to-own agreements, a portion of the monthly rent paid by the tenant may be credited towards the eventual purchase price of the property. These rent credits act as a form of down payment when the tenant decides to exercise the purchase option.
- Lease Purchase Agreement: While some lease purchase agreements may include rent credits, they are not as common as in lease-to-own agreements. In a lease purchase agreement, the primary focus is on the tenant’s obligation to buy the property rather than building equity through rent credits.
- Flexibility:
- Lease-to-Own Agreement: Lease-to-own agreements offer more flexibility for the tenant. Since they have the option to buy but are not obligated to do so, they can choose not to purchase the property and simply continue renting or move out at the end of the lease term.
- Lease Purchase Agreement: Lease purchase agreements are less flexible for the tenant. Once the lease term is over, they are generally required to proceed with the purchase. This may suit tenants who are more certain about their decision to buy the property.
- Legal Implications:
- Lease-to-Own Agreement: Lease-to-own agreements may have fewer legal complications if the tenant decides not to buy the property. Since the tenant has the option to walk away, they are not necessarily in breach of the contract if they choose not to exercise their option to purchase.
- Lease Purchase Agreement: Lease purchase agreements create a stronger legal obligation for the tenant to purchase the property. If they fail to do so, it may be considered a breach of contract, and the landlord/seller may have legal remedies available.
It’s essential for both parties to clearly understand the terms and differences between these agreements before entering into such arrangements. Consulting with a real estate attorney can help ensure that the contract reflects the parties’ intentions and protects their rights and interests.
The Pros & Cons
Lease-to-own and lease purchase agreements both have their own sets of advantages and disadvantages. Let’s take a look at the pros and cons of each.
Lease-to-Own Agreement
Pros:
- Flexibility: Lease-to-own agreements offer flexibility for the tenant. They have the option to buy the property but are not obligated to do so. If they decide not to purchase, they can simply walk away at the end of the lease term without any further obligation.
- Time to Build Equity: A portion of the monthly rent may be credited toward the eventual purchase price, allowing the tenant to build equity in the property over time. This can be especially beneficial for tenants who may not have enough for a substantial down payment.
- Try Before You Buy: Tenants can live in the property during the lease period and get a feel for the neighborhood, amenities, and any potential issues the property may have before committing to purchase.
- Lock-in Purchase Price: The purchase price is typically determined at the beginning of the lease agreement, so if property values increase during the lease term, the tenant may secure a better deal.
Cons:
- Higher Monthly Payments: Lease-to-own agreements often have higher monthly rent payments compared to traditional leases, as part of the rent goes toward building equity.
- Non-Refundable Option Fee: The upfront option fee paid by the tenant is usually non-refundable. If the tenant decides not to buy the property, they may lose this money.
- Uncertain Purchase: There is no guarantee that the tenant will be able to secure financing or qualify for a mortgage to purchase the property at the end of the lease term.
Lease Purchase Agreement
Pros:
- Strong Commitment: Lease purchase agreements create a stronger commitment for the tenant to buy the property. This may appeal to individuals who are confident about their decision to purchase the property.
- Price Lock: The purchase price is fixed at the beginning of the agreement, protecting the tenant from potential price increases in the future.
- Potential for Rent Credits: Like lease-to-own agreements, some lease purchase agreements may offer rent credits, allowing the tenant to build equity over time.
Cons:
- Limited Flexibility: Lease purchase agreements are less flexible for the tenant. Once the lease term is over, they are generally required to proceed with the purchase. If they choose not to buy, they may face legal consequences or lose certain amounts paid as part of the agreement.
- Higher Risk: If property values decline during the lease term, the tenant may be locked into purchasing a property at an inflated price.
- Loss of Investment: If the tenant is unable to secure financing or qualify for a mortgage at the end of the lease term, they may lose the equity they’ve built and any additional funds invested in the agreement.
In both cases, it’s essential to thoroughly review the terms of the agreement, consider personal financial circumstances, and seek legal advice to ensure that the chosen option aligns with the individual’s long-term goals and financial capacity.
Benefits for the Seller
Both the Lease-to-Own and Lease Purchase benefit sellers looking to sell fast without having to work with a realtor. In addition, if the home is free and clear of any liens, either option provides residual income.
Unless the seller is looking for a lump sum at one time, both options could work well depending on the seller’s needs. However, the seller will essentially be financing the buyer. If the buyer fails to follow through with the contract, the seller will be held liable for paying any pre-existing mortgages on the home.
Benefits for the Buyer
For a buyer without sufficient funds or credit to obtain a loan, opting for a lease-to-own or lease purchase of a home could be the perfect solution if a seller can be found.
Lease-to-own is an excellent choice for buyers who have a less secure future and are still determining if they will actually purchase the home after the term is up. Lease purchase is better for buyers who are already bent on buying property and are prepared to follow through with a 15-30 year term.
The biggest benefit, however, is that a lease-to-own or lease purchase prohibits the owner from selling to any other party while the agreement is in force. In essence, the buyer has exclusive rights to the property, barring any undesirable scenarios such as breach of contract or the buyer’s inability to secure a mortgage at the end of the term.