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?
A lease to own is a contract in which the buyer will be leasing or renting the home for a specific period of time, after which they have the option to purchase on or before the end of the contract term.
On the other hand, a lease purchase is a contract in which the buyer is obligated to purchase the home through monthly payments for a set number of years. For example, the buyer agrees to buy the house at $150,000 for 20 years at a 6.75% interest rate.
With a lease to own, the buyer can opt-out after the contract is up. Whereas in a lease purchase, the buyer is locked into the sale. Each option has its benefits and drawbacks depending on the given situation.
Lease-to-Own
Pros – Leasing to own is great for buyers who want to try before they buy. They are able to make monthly payments as rent, with a portion going towards the overall principal of the loan. This will reduce the loan amount they need at the end of term and works favorably for buyers who may need to clean up their credit.
Cons – The problem with this arrangement is that if the buyer cannot obtain a loan at the end of the lease, they might have to sell to someone who can get one. A buyer’s credit rating may not qualify for a traditional mortgage loan, which increases the risk of being unable to purchase the home. In this case, an ordinary rental would be a cheaper alternative.
Lease Purchase
Pros – The lease purchase option is suitable for buyers who already know they want to purchase the home but cannot get a mortgage loan. They will be able to pay the seller the same way they would a traditional lender.
Cons – If the buyer cannot afford the home at a later time or have a change of mind, they will be held liable for the entirety of the loan. Because the home is still owned by the seller and not a bank, the buyer will not have the option of foreclosure or bankruptcy to cover the cost of the loan.
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.