Traditional Rent-to-Own Agreements

Renting to own provides an opportunity for buyers and sellers to meet on a price, while still providing a level of affordability for the buyer. A seller may command a top price for the home, while a buyer can slowly accumulate the necessary funds and the credit to purchase it. They're not for everyone, however. Buyers and sellers should be certain to secure experienced representation and exercise caution.

Renting to Own: What It Is and Isn't

It's not a mortgage or seller financing, but it's not a garden-variety lease, either. Rent-to-own deals, also known as lease-options, operate similarly to a regular lease: The seller must maintain the property and pay his own mortgage and property insurance. The renter, or buyer, makes monthly rent payments, does not have an equity stake and may be responsible for small repairs. However, if all parties are willing to perform, at the end of the lease, the home will become the property of the renter.

The Sale Price and Option Fee

The seller and renter (or future buyer) should treat the lease as a purchase agreement and must agree on a purchase price up front. Purchasing an independent appraisal is wise and guarantees that the purchase price will be backed up with comparable home data. Once the purchase price is agreed upon, the buyer must pay to the seller an option fee of 1 to 5 percent of the sale price. This fee is nonrefundable if the home isn't purchased by the buyer, but it is applied as a credit if the sale is consummated.

The Rent Premium and Term

In addition to paying the option fee, the buyer must also pay above-market rent. This is called the "rent premium," and this premium is applied to the purchase price, either in full or in part. It's also not refundable in the event the buyer can't perform. However, the rent premium is a great way to save slowly toward the home's purchase and provides a good incentive for the buyer to complete the transaction.

The length of the term is negotiable. Often, lease-option deals last anywhere from two to five years. The lease ends with the buyer securing a loan and purchasing the home from the seller, using the credits from the option fee and the rent premium.

Pros and Cons

The most difficult obstacle to overcome is if the real estate market suddenly declines or increases so much that the sale price becomes untenable for either the buyer or the seller, providing little incentive to complete a sale. Another obstacle occurs if the buyer is unable to afford or obtain the mortgage required to purchase the home. If that occurs, the buyer forfeits the rent premium and the option fee, which usually totals several thousand dollars. At that point, the buyer must either move out, renew the lease or attempt to secure alternate financing (seller financing or a land contract may be options).

Because deals don't always work out, buyers should be cautious not to agree to purchase homes that they may not be able to afford. Sellers should insist that buyers fill out thorough applications. Both parties should be frank with each other about why they're entering the deal, to avoid wasting time and resources.

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