Buying a house can be expensive because few people can raise the asking price as a single payment. The alternatives for homebuyers are mortgage or rent-to-own agreements. Buying a house through a mortgage requires the homebuyer to have good credit and a financier such as a bank, which can be lengthy due to all the formalities.
A rent-to-own lease agreement allows homebuyers to rent a house with an option to buy before the expiration of the lease term.
Therefore, a rent-to-own lease agreement is a contract between a landlord and a tenant that allows tenants to live in the rental property for a given period within or after which they have the option to buy the property.
Elements to Include
A rent-to-own lease agreement typically consists of two components; a standard lease agreement and an option to purchase. The following information will, therefore, usually be included in the agreement:
- Tenant/Buyer Name and Address
- Landlord/Seller Name and Address
- Property description
- Monthly payments ($)
- Lease period
- Utilities and Services
- Grace periods and late fees
- Purchase Price
- Closing Date
- Property Disclosures
Lease Option v/s Lease Purchase
A rent-to-own lease agreement can either be a lease option or lease purchase. These two types of agreement are different even though they are used for the same primary objective; rent a house with an option to buy. A lease option is more flexible because it allows the tenant to rent the property with a right but no obligation to buy the house after the lease period. Conversely, with a lease purchase, the tenant has both the right and is obligated to purchase the property before the end of the lease period. A lease purchase is, therefore, more stringent than a lease option.
How Does it Work?
If a landlord decides to rent out their property to an individual who is willing to rent the property with an option to buy, there are specific steps they need to take into consideration. The process of renting-to-own includes the following steps:
The buyer must pay upfront a non-refundable fee referred to as option money, option fee, or option consideration. The fee ranges between 1-5% of the purchase price but is negotiable.
Start rental agreement
Both parties should then start the rental agreement negotiations. At this point, they can decide the following terms and conditions; monthly payments, lease term, security deposit, utilities and services, maintenance, and other terms.
Provide the option to purchase
After discussing the rent-to-own lease agreement’s essential details, the landlord and the tenant can discuss the tenant’s option to purchase. Terms that can be discussed are lease-option or lease-purchase, purchase price, down payment, applying rent to the principal (purchase price), and terms of the option to buy. In addition, other terms such as property maintenance obligations can be discussed at this point.
Tenant’s personal information
The tenant is then expected to produce personal information and give consent for credit and background checks. Finally, a rental application form can be given to the tenant to fill out. Background check service providers can be used for this exercise and check through state and national directories for criminal charges.
Verify the tenant’s income
Landlords should then aim to verify the tenant’s income to determine their financial capability or liability to fulfill contractual financial obligations. For example, tenants can produce bank statements dating back to 3 months, employment verification letters, past two years’ tax return reports, or past two weeks’ pay stubs as proof of their income. The landlord should then decide to accept or reject the tenant’s rental application.
Sign the lease with the option to purchase
If the tenant is accepted, a completed rent-to-own lease agreement should be signed by both parties and executed. Then, the tenant pays the first month’s rent, security deposit, prorated amount (if any), and other fees. Afterward, the landlord should hand the tenant keys, pin codes, access codes/keys, etc., and the tenant can move in.
Tenant starts to live
The tenant can start living in the property under the lease agreement stipulations. The tenant is expected to duly pay monthly rent and cover any other expenses, usually utility bills, as agreed with the landlord. In addition, the landlord should work to ensure the tenant enjoys their right of “quiet enjoyment.”
Activate the right to purchase the property
Once the tenant is ready to activate their right to purchase the property, they should inform the landlord or agent. Paying a “consideration” or earnest money deposit is often a way to activate the right to purchase the property.
Enter into the purchase agreement
Afterward, both parties can now enter into a purchase agreement to implement the rent-to-own lease agreement’s option to purchase. The agreement should highlight the financial contingency, inspection periods, boundary survey, property defects, and closing sale.
Attach require disclosures
Next, the landlord should submit any disclosures about the property. Examples of disclosures include lead-based paint disclosure, mold, etc. Mandatory disclosures are often dependent on state requirements.
Final right on the property
Lastly, the homebuyer is expected to pay the remaining balance before or on the closing date. After receiving the funds, ownership is transferred to the new homeowner (former tenant) by signing a deed to the property. The new homeowner then files the deed with the county recorder’s office, and a filing fee is paid (shared between the seller and the buyer). Finally, the transfer is complete, and the property now belongs to the new homeowner.
How to Write the Agreement
A rent-to-own lease agreement is meant to outline all the details about the parties involved, lease, purchase, and legal details. Follow the steps given below to make an enforceable rent-to-own agreement:
The rent-to-own lease agreement should start with a statement identifying when the agreement was written and the parties involved. The details should be provided as follows:
- Date: The exact date of execution should be indicated. Ensure that the month, year, and day are clearly stated.
- Seller’s information: The landlord’s name, also identified as the seller, should be given. Ensure to use legal names as they appear on the property deed.
- Buyer’s information: The homebuyer’s official name should be written down exactly as it shall be written in the property title deed if the purchase goes through.
After the open statement and identifying the seller and the buyer, a description of the property in question should be provided. The following information is used to give a brief description of the property:
- Property Location: The location where the property is situated needs to be indicated. The rent-to-own agreement should indicate the county where the property is located. This represents the jurisdiction under which the agreement falls.
- Complete address: In addition, the mailing address of the property should be given as part of the property description.
The next section of the rent-to-own lease agreement should provide rent terms that the tenant and the landlord previously agreed on. In addition, the following information should be captured:
- Agreed rent amount: The agreement should indicate the total amount of money expected to be paid by the tenant by the end of the lease term. It is a single figure that sums up all essential rent payments, utilities and services excluded.
- Monthly payment: Next, indicate the exact amount the tenant shall be paying every month for the entire lease term. Ensure it is given in the correct monetary units.
- Due date: Each monthly payment is expected at a given date every month. This date should be given.
- Security deposit: A security deposit is essential to cushion the landlord for any property damages that can happen in between the lease term and rent defaults. State the precise amount that will be paid as a security deposit.
Utilities and services
Utilities and services are an essential part of renting. Utilities include water, electricity, HVAC, standard areas maintenance, etc., which come at a cost. Therefore, the rent-to-own lease agreement should outline how these utilities and services will be shared between the two parties involved.
- Tenant’s obligation: The agreement should list all the utilities and services the tenant is obligated to cover. Standard utilities that befall tenants are water, electricity, and gas.
- Landlord’s responsibility: The agreement should outline all the utilities and services the landlord is expected to pay for. For example, landlords are expected to assume everyday obligations are costs associated with HVAC, sewerage services, garbage collection, etc.
The rent-to-own lease agreement should then clarify the first and last date on which the option to purchase is adequate. Typically, the option to purchase period commences later than the move-in date.
After, declare how much the tenant shall be expected to pay as “consideration.” Remember that the fee is non-refundable. This fee should be added to the purchase price if the tenant falls through with the agreement.
Next, the rent-to-own lease agreement should provide details about the purchase price of the property. This information should be supplied as follows:
- Total amount: A sum of the total purchase price should be stated. Give the amount in words and figures for clarity.
- Monthly payments: The portion of monthly rent that shall be credited towards the purchase price should also be indicated.
Country and state
After the purchase price, write down the jurisdiction under which the rent-to-own lease agreement falls. The jurisdiction is given by stating the county and state where the property is located.
Finally, the document must be signed to be legitimate. Appropriate signatures must therefore be supplied in the document.
- Seller’s signature: The seller’s/landlord’s signature should begin. They must sign and state their name and date when they signed.
- Buyer’s signature: The buyers/tenant’s signature then follows. They are required to sign and indicate the date of signing too.
- Witness signature: A rent-to-own lease agreement can be witnessed to enhance its enforceability further. The witness should sign, provide their name and date of signing.
Rent-to-Own Lease Agreement Template
Preparing a rent-to-own lease agreement is more accessible when done using a rent-to-own lease agreement. A template is a form that outlines all the relevant details that ought to be input in a standard rent-to-own agreement. Upon customization, users can produce professional and up to standard rent-to-own lease agreements. You can find such templates on this website easily. They are free to use and easily downloadable from this website.
Obligations of the Tenant
A rent-to-own agreement comes with varying obligations from traditional lease agreements. Below are various obligations tenants should anticipate in a rent-to-own lease agreement.
The tenant makes necessary repairs to the rental property
With an option to purchase in place, tenants build equity in the property over the lease term; consequently, they are obligated to pay for any repairs on the property. As per the agreement, the tenant is deemed the eventual owner and will be more motivated.
Tenant must fulfill lease obligations
The tenant is obligated to fully comply with the terms and conditions of the lease agreement to rightfully acquire their right to the option to purchase the property at the end of their tenancy. This means they remain a tenant of the homeowner, and the landlord remains the rightful owner of the property until the option to purchase is earned by the tenant and implemented. Any breach of the rent-to-own lease agreement renders the option to purchase null and void. However, if the tenant rightfully earns the option to purchase, the property can then be transferred to the tenant following the lease-to-purchase guidelines provided in the rent-to-own lease agreement.
Tenant must pay timely rent
The tenant must make timely rent payments until the last date of the agreement for the option to purchase to be still effective. Also, with a rent-to-own lease agreement, the tenant may have to pay higher rent than a standard lease as a percentage of the monthly rent is credited to an escrow account, which can be added to the purchase at the end of the lease term price or refunded to the tenant.
Rent-to-Own home maintenance
The tenant and the landlord should agree on who is responsible for repairs and maintaining the property. While repairs typically befall the tenant, they must be listed in the rent-to-own lease agreement to avoid overlapping responsibilities. Maintenance typically involves lawn mowing, painting, cleaning, etc.
Pre Considerations for the Buyers
A rent-to-own agreement will usually last over a long period. Therefore, before committing to the agreement, there are certain things tenants need to put into consideration:
Choose the correct terms of the agreement
Always evaluate the terms of the rent-to-own lease agreement before signing it. A lease option is more favorable to tenants than a lease to purchase. In addition, a lease option is more flexible and gives tenants a way to opt-out if they cannot buy the house at the end of the lease period.
Hire a qualified attorney
It is always beneficial to get an attorney to review the document before signing. A lawyer can be consulted to ensure no legalese has been used to indicate something other than the tenant’s preferences. Also, have them explain any hidden legal terms.
Read the contract carefully
Carefully review the contract. Tenants should understand the rent-to-own lease agreement’s contents, their contractual rights, and obligations. Note down deadlines, fees, purchase price, maintenance terms, etc.
Investigate the property
Tenants should conduct a formal inspection and appraisal on the property to ensure they get what they are bargaining for. Tenants must verify that the property taxes are up to date, the house is in good condition, and no liens are on the property.
Research the seller
Conduct quick research on the seller to obtain basic information such as credit report, title, and how long the house belongs to him. Houses, where the seller is the outright owner are more preferred.
Double-check the fine print
Examine the final agreement to ascertain conditions that invalidate the option to buy. The option to buy is usually contingent on the tenant fulfilling certain obligations; tenants should ensure they are aware of these obligations to protect their right to buy a property through a rent-to-own lease agreement.
Pros and Cons
A rent-to-own lease agreement does not come short of advantages and disadvantages to each of the involved parties. Some of these pros and cons have been discussed below:
A rent-to-own lease agreement enables landlords/sellers to collect higher monthly payments and gain a long-term tenant. This way, they can sell houses that have had difficulty selling. Also, a landlord is exempted from maintenance costs and real estate commissions. Furthermore, the principal amount (purchase amount) is not taxed; only interest or capital gains are taxed. Lastly, the seller retains their right to the property and can recoup if the tenant fails to fulfill the agreement’s terms.
The cons of using a rent-to-own lease agreement are as follows; the tenant may fail to maintain the property during their tenancy, and the repairs might be costly in the end. Also, once entered, the landlord is obligated to sell to the tenant as long as the tenant activates the option to buy. Finally, the landlord cannot pull out of the agreement even if the house’s value has shot up due to appreciation.
A rent-to-own lease agreement benefits the buyer or tenant in that it offers a way to own a house even if the buyer does not have the entire amount available or cannot qualify for a mortgage. Also, a rent-to-own agreement is flexible in that the tenant can buy or walk away after the end of the lease term. Finally, a rent-to-own lease agreement is more affordable than a mortgage in that the tenant can avoid interest typically paid with a mortgage.
The disadvantages of using a rent-to-own lease agreement to buyers include being responsible for any repairs on the property even if they are discovered after signing the agreement. In addition, missing a single payment can result in the annulment of the purchase option and loss of the option fee. Also, if the seller fails to make mortgage or tax payments, liens to the property can accrue, which might cause issues at the time of purchase of the property.
Frequently Asked Questions
How does a Rent-to-Own home contract work?
A rent-to-own home contract allows potential homebuyers to rent a property they want to own at the end of the lease period. The tenant pays a slightly higher rent, and a portion of the rent is used as partial payments towards the purchase price. At the end of the tenancy, the buyer/tenant can decide to buy or not buy the property. If they decide to purchase, they pay the remaining balance, and of title to the property is transferred from the landlord to the tenant.
What are some pitfalls to watch for?
As much as a rent-to-own agreement can be beneficial to a homeowner and a potential homebuyer, it has its downsides. Buyers should look out for terms of the option clause as it is typically easily nullified. Also, they should look out for damages to the property and costs of repairs. Sellers should be wary of appreciation and depreciation of the property value to ensure they fetch a fair price for their property. Also, rent-to-own agreements are associated with uncertainty; tenants can always back out of the option to purchase.
What happens if the buyer (tenant) chooses not to purchase the home?
Ordinarily, a rent-to-own agreement does not dictate that a tenant must buy a house. Tenants still enjoy the right to the “option” to purchase the property. They can therefore walk away without legal ramifications. The seller is, however, allowed to withhold the option fee as it is non-refundable.
What ought to be considered when renting to own?
Multiple things ought to be considered when renting to own a house. While each lease agreement will vary from the other, it is advised that buyers investigate the monthly rent, portion of rent added to the purchase price, the purchase price, repairs, and history of the house. In addition, ensure there are no liens to the house.