What is a home with an option to rent with the option to buy or lease?

A home purchase with a lease option (also rent-to-own purchase” or “rent-to-own”) is a lease combined with an option agreement to pay for the home within a specified period of time, usually three years or less, at an agreed cost Borrower pays an option charge, 1% to 5% of cost, which is credited toward purchase value Borrower pays monthly rent and additional rental payment also paid credited to purchase price If the purchase option is not exercised, the buyer forfeits both the non-refundable option fee and rental premiums paid.

As with any type of monetary contract, rent-to-own offers can be arranged in such a way that all of the reimbursement flows to one party and none to the other. Buyers should be especially vigilant. But the rent-to-own strategy has a sound tax rationale, which means it can be arranged in a way that wins both parties.

Characteristics of the rental contract with the option to buy

A rent-to-own has 6 main needs. The home’s sales price and rent are determined by the market, but are subject to commitment just like in an outright purchase transaction or a rental transaction. Buyers typically know less about the market than sellers, which puts them at a weakness unless they do a little research, which is sensible.

Buyers generally prefer a long option period, as it provides additional time to build equity and repair credit. An extended period can be a boomerang for them, however if they can never exercise the option, they lose the rent payment they have been paying all along, plus the non-refundable option fee. Sellers generally like a short option period best, but not too short, or you’ll never buy the home.

The option price and the rental payment are viewed in different ways by buyers and sellers. For the renter/buyer, they are equity in the home they will soon buy. By fully anticipating that they will exercise the option, the only cost is the interest they would otherwise have earned. For sellers, on the other hand, these payments are the biggest promise that they will sell their properties. If they don’t sell, the payments are retained as profit. The benefit to the seller often outweighs the cost to the buyer, making a lease option transaction viable and beneficial to all.

Using a Lease to Buy Agreement

Rent-to-own offers favorable terms for homeownership to consumers who cannot qualify for credit from any source, but who are willing to bet on it themselves. The bet is that before the rent-to-own period expires, they will qualify for the financing they require to make the purchase option effective. During the rent-to-own period, they have the opportunity to rebuild their credit and build equity while living in the home.

Consumers who need to rebuild their credit rating for the term of the rent-to-own agreement should understand that paying their rent on time will not do it. Rent payments from tenants are not used to build your credit score. Fair Isaac, the company that developed the credit score, recently submitted an “expansion” score based on non-traditional credit data, which does not yet include individual tenant rent payment information. Rent-to-own buyers who need a better credit score should focus on their credit cards, loans, and other bad debts.

The right not to exercise the option has value to buyers, even if it is costly. You may find that something is seriously wrong with the house, the neighborhood, or even the neighbors. The money left on the table with a rent-to-own is often much less important than the cost of an outright purchase followed by a quick sale.