Rent To Own or Lease Option:
This is an amazing tool to buy a home or investment property. Sadly, due to a lack of accurate information, this tool has been greatly misused. Here at The AFTHA Program, we work with thousands of people every day who are completely misinformed about how rent to owns actually work. Just like any tool, if not used correctly it could be very dangerous.
In this post,we will give you some facts about rent to own homes. We will cover what lease options contracts (rent to owns) really are and how they are being used today, how they have been abused and the risks associated with them, and how to determine if they are the right tool for you or if there are alternatives out there.
First, let’s dissect the phrase Lease Option. A lease Option or better know as a Rent To Own is actually two different contracts put together. Its a standard Lease Contract with an Option Contract attached to it.
An Option is a one-sided contract between a buyer and seller. It outlines the duration of the option (number of years) and the selling price. The seller is obligated to hold the property for the full term of the contract and is only allowed to sell to the contracted buyer for the agreed upon price. while the buyer can choose to either execute the option (buy) or not.
In order to enter into this type of contract, the buyer would have to offer valuable consideration (money) to the seller for the option to buy. This money will be forfeited if the buyer fails to buy the property.
Here’s an example of how options work:
I can wait, but I risk having to pay much more for this home if prices do go up.
I can buy it now and risk property prices dropping
Or, I can offer the homeowner money to give me an OPTION on the property.
“Well, if I want to minimize risk, option 3 would probably be best. I can give the owner, for example, a $2,000 for a 2-year option to buy their property at $5,000 above current market price. If I’m right and prices do go up significantly than I execute my “option” and buy the home for much less than the current market value but, if they don’t, I’m only out a $2000.”
Options are really made more for investors who want to mitigate their risk without sacrificing potential profits.
A Lease is a contract between two parties, where one conveys land or property to another for a specific term (time), typically in return for monthly payments.
Lease Options A.K.A. Rent To Own:
In today’s housing market, lease options or rent to owns work much the same way. A lease is written up and an addendum (option contract) is attached to the back of it. Usually, you will pay 20% above the market lease price for this property and a portion of your payments will go to your down payment at the end of your lease, typically that extra 20%. You will also be agreeing to pay either asking price or greater for this property.
You will be locked into this price no matter what the housing market does, this could be good or bad. Like all standard leases, you will have to put first, last, and security deposit down. You will also need to pay the option fee, usually between 1% to 10% of the agreed-upon selling price. If, the option is executed than this fee will go against the selling price of the home.
If not, it’s none refundable. You should also have the home inspected and appraised, this will come out of your pocket. As well as hire an attorney to examine both contracts to protect your interests.
You and the homeowner would enter into a contract that will dictate how the lease and the option will be executed. It is important to remember you are really doing two different things here,
you will be combining a lease contract with an option contract and everything is a 100% negotiable. Just remember that the seller or his agent will know they hold almost all the leverage here and will try to use it to their advantage.
Most of the time the people seek out Rent To Own Homes because they think they can’t qualify for an FHA or conventional loan or don’t have the money for a down payment. What they fail to realize is that almost always, a Rent To Own will require more money down and carry a much higher monthly payment (for the time of the lease) than a mortgage. Plus, if they fail to execute the option (buy the home at the end of your lease), they run the risk of losing all the money they invested.
Rent To Own, A Story
of Risk and Abuse:
First, let’s evaluate the risks. Before you can avoid pitfalls, you need to know they exist. So here are some common ones to be aware of.
A total loss will result in the full loss of, the option fee, rent payments (including all the money that has been set aside for the down payment), and more than likely your security deposit as well.
Most lease options agreements favor the seller and have clauses that allow them to evict you. Here are some lease violations that could cause an eviction. (An eviction in most cases will result in a “Total Loss”.)
Nonpayment of Rent
Illegal or Drug Related Activity
Any Violation of The Clauses in the Lease or Addendum
There are case where homeowners who are falling behind on mortgage payments will post their home as a rent to own. They will take your money and let the bank foreclose on the home. (Could result in a “Total Loss”, you will have to sue the homeowner for breach of contract.)
Property price can jump significantly in the 2 to 5 years you will be leasing.
The fact that you hold an option on this property at greatly lower selling price than the current market value. Could make the owner have second thoughts and sell the home as a tenant occupied property, at the full market value.
Typically the owner will give back the option fee and money set aside for the down payment to dissolve the contract but, this is not always the case and you may have to end up taking them to court. (Could result in a “Total Loss”, you will have to sue the homeowner for breach of contract.)
- The worse pitfall of all is, you complete the full term of the lease but you fail to secure financing to buy the property. This will leave you in breach of the option contract and result in a, you guessed it, A Complete and Total Loss.
Keep in mind that 2 to 5 years is a really long time and anything could happen. When you own a home and have a mortgage, there are protections that will safeguard you in time of crises. With rent to owns, unless they are specifically written into the contract, there are practically none
The scenario above is only an example, your individual break down maybe be different.
If you could use our help with figuring out what option is best for you, don’t hesitate to reach out.