Legal Issues with Rent-to-own Housing

Although renting to own sounds like a simple solution to a difficult situation, it's a path lined with land mines. Buyers who may be in a precarious financial situation should take extra care to ensure that they fully understand the terms of the deal, and sellers should consider why their tenants can't get a mortgage to begin with. Both sides should hire expert representation who can fully advise with regard to state laws.

Understanding the Deal

The tenant must fully understand that the option fee and rent premium do not constitute an ownership stake in the home; they merely give the tenant the right of first refusal to purchase the home at a previously-agreed-upon price while also securing financing for the purchase within the lease term. Failure to secure financing often results in the loss of the option fee and the rent premium, a setback that few tenants can easily withstand.

Several state attorneys general have fielded complaints, often from first-time "buyers" who didn't understand these points clearly; as a result, many states have begun to regulate the rent-to-own market to include more protection for tenants. These protections include a full or partial refund if the tenant can't secure a mortgage in the event of a death, divorce, job loss or other extenuating circumstance over which the tenant lacks control.

Clear Title Issues

Unfortunately, unscrupulous landlords have sullied the deal's reputation by offering rent-to-own deals on properties to which they do not have clear title. This often occurs in illegal or unapproved subdivisions, and without a clear title, ownership cannot pass from the seller to the buyer. Naive buyers who don't fully understand the deal terms don't realize that their chances of consummating a sale are slim, if not none. If the sale isn't made, then the landlord exercises his right not to refund the option fee and rent premium, resulting in a significant financial loss for the tenant.

Tenant Financial Problems

The landlord should insist that a tenant considering a lease option deal complete a full application while also running a credit check. Tenants in lease option deals often have poor finances and credit that make the purchase dream unrealistic. If the price of the home appreciates significantly over the course of the lease term, the problem is magnified -- of course, it's not much incentive for the seller to consummate a sale, either.

For this reason, tenants should strongly consider inserting language that provides for a full or partial refund in the event a mortgage cannot be secured.

Landlord Financial Problems

If the landlord is in default, that's an even bigger problem. If the home forecloses, because the law does not consider a rent-to-own arrangement to be the same as a sale contract, the tenant stands not only to lose the option fee and rent premium, but also may be forced out of the home.

For these reasons, both tenants and landlords should hire expert representation and expect full disclosure from each other with regard to title and financial issues. "Trust, but verify" is an excellent motto that perfectly describes the approach that should be taken to increase the chances that a sale will occur.

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