If you’re dreaming of home ownership but don’t quite have the down payment or credit profile to make it a reality, a lease-to-buy option is one of several avenues to consider.
What is a lease-to-buy option?
A lease-option is a contract in which a landlord and tenant agree that at the end of a specified period, the renter can buy the property. The tenant pays an upfront option fee and an additional amount each month that goes toward the eventual down payment. If you decide not to purchase the home at the end of the agreement, you’ll lose your option fee, as well as any money you put toward a down payment, but a seller can’t come after you for opting not to follow through with the purchase.
Lease-option contracts go by other names, including:
Questions to ask
Lease-with-option-to-buy contracts can be complicated, so make sure you’ve answered the following questions before moving forward:
1. How is the deal structured?
You’ll want to understand all of the terms of the deal, including the length of the agreement and the amount of the option fee, which can be any amount but typically varies from a few hundred dollars to 20% of the value of the home. Typically, you’ll pay above-market rent, with a portion of your rent going toward a future down payment on the property. You’ll want a real estate lawyer who has experience with these agreements to look over the contract before you sign it.
2. What’s my plan to prepare for the purchase?
Talk to a lender before entering into the lease-option-to-buy agreement to make sure that you’ll get credit for the money you’ve paid to the homeowner on top of your rent payments toward your purchase. This way, you’ll know how much money you’ll need to cover a down payment and closing costs later on.
“When you do a lease-option, you’re betting that you’re going to qualify for a mortgage and be able to execute and buy the property,” says Timothy McFarlin, a Los Angeles-based real estate lawyer. “Make sure that you have a path to do that.”
In addition to amassing a down payment, use your time renting to improve your credit in order to qualify for the best possible rate when it’s time to buy the home. In other words, pay down your debt, avoid opening new credit accounts, and pay all of your bills on time.
3. How is the housing market in the area?
You can either agree on a purchase price in advance or agree that the sale prices will be contingent on an appraisal at the time of sale. Home values can fluctuate during your lease period, so it’s important to know whether the price can be adjusted before you buy.
In a market where home prices are going up, it can benefit the buyer to lock in a price in advance. But in a market where prices are falling, you may end up agreeing to pay more than the home will be worth at the time of purchase. In that scenario, you might have a harder time getting approved for a mortgage or assembling a sufficient down payment plus closing costs.
4. Who is responsible for what?
The lease-option contract should spell out who is responsible for the maintenance and repairs of the home, as well as who is going to pay for homeowners association fees and utilities. You’ll need to have renter’s insurance, and the owner is responsible for purchasing landlord’s insurance.
5. Do I need a home inspection?
As with any home purchase, it’s critical to get a professional home inspection to ensure you’re making a sound investment. It will cost a few hundred dollars upfront, but it’s worth it to ensure that a property doesn’t have major red flags. If the inspection report uncovers costly problems, you’ll want to work out when those repairs will take place and who’s going to pay for them.
6. Have I considered other options?
A lease-option-to-buy arrangement can be a solution for some potential home buyers, but it’s not right for everyone. If you’re not certain that you’re going to be able to purchase the rental home at the end of the lease period, you might be better served with a standard rental agreement. Meanwhile, take time to work on your credit, save up extra cash, and get your finances in better shape so you can strike when the time’s right. After all, it would be a waste to plunk down extra money on a lease-option and above-market rent without making any meaningful progress toward home ownership.
Kimberly Cole, a spokeswoman for Navicore Solutions, a nonprofit financial counseling company, suggests that potential buyers look into a down payment assistance program from the U.S. Department of Housing and Urban Development.
“The terms of those programs might serve you better and give you an opportunity to buy right away, as opposed to being beholden to a landlord for a year,” Cole says.
Once you’ve determined that a rent-with-option-to-buy agreement makes sense for you, ask a real estate lawyer to look over the paperwork, which may include a separate rental agreement and purchase contract. Have your lawyer walk you through the agreement and ask for clarification on anything you don’t understand before signing on the dotted line.