Rent-to-own or lease-to-own agreements are traditional rental agreements that also provide an option for a tenant to purchase the rental home.
This arrangement is more common in single-family homes, but sometimes can be implemented for duplexes, apartments or condos.
This agreement has benefits for landlords, as well as tenants.
Let’s discuss details and have the rent-to-own contract explained.
Anatomy of Rent-To-Own Agreement
A rent-to-own agreement usually consists of two agreements: a typical lease agreement and a separate document that outlines the option to purchase. They can be incorporated in one document or exists as two separate documents.
In rent-to-own arrangements, the property remains with the landlords unless a tenant chooses to exercise the right to purchase a property. The legal underpinning of such arrangement is renting, not the purchase transaction.
The rental agreement is usually identical to the ordinary lease agreement and includes provisions regarding the amount of rent to be paid, lease period, repair and maintenance responsibilities of tenant and landlord.
An option to purchase guarantee the tenant a right to buy the rental property within a defined period of time, usually in exchange for the additional fee. This fee is usually paid in the form of the higher than average rent, part of it is applied towards the house purchase.
In case if the tenant decides not to purchase the property, the landlord is not obligated to return the option fee or refund the portion of the rent. There is a lot at stake for both tenant and landlord, so such contracts should be meticulously drafted.
Rights and Obligations
The typical lease-to-own arrangements have some distinctive features that distinguish it from the ordinary lease agreements.
Similarly to the standard rental agreement, the tenant is obligated to make timely payments of the agreed monthly fees.
In the rent-to-own agreements, the rent is usually substantially higher than in the regular set up. This is due to the fact that the percentage of the monthly rent is usually put in the escrow account.
It is the duty of the landlord to set aside this portion of the rent. The landlords usually apply those rent payment toward the principle of the house or refund the tenant upon the purchase. In such a way, the tenant is building an equity in the house during the renting period.
In contrast to a traditional renting where the landlord is responsible for all repairs and renovations, in the rent-to-own agreements tenant is usually responsible for the repair and upkeep of the rental property.
Most tenant and landlords consider it a fair game since at the end of the day tenant owns the house. Additionally, a tenant who is financially responsible for the property will generate less wear and tear.
Until the right of the purchase is exercised, the property is legally owned by the landlords.
Despite the fact that tenants are responsible for all the repairs and maintenance, they still have to comply with all of the conditions of the rental agreement. This means that tenants cannot have unauthorized residents or pets if the lease explicitly states that.
If the tenant violates the terms of the contract, the purchase option is voided. The tenant will lose the option fee and the escrow percentage of the monthly rent payments.
Risks and Benefits
A rent-to-own agreement is a good option for the tenant who wishes to become a homeowner, but due to the lack of funds for the down payment or bad credit score is not eligible for the mortgage.
This arrangement allows a tenant to invest and gradually build equity in a property while leaving the possibility to opt out.
The financial situation can change for the worse or for the better. The tenant might find a better housing option, or fail to accumulate necessary funds for the purchase.
If the tenant chooses not to exercise the right to purchase the property, that might entail serious financial consequences- loss of the option fee or the fund accumulated on the escrow account.
In the same time, the tenant in any way is not obligated to purchase the property. The decision to forfeit the option won’t damage tenant’s credit history.
Landlords can reap the benefits of the rent-to-own arrangements as well. For example, landlords who want to sell their rental property, but have a hard time to do so, might find a buyer through offering the rent-to-own arrangement.
During the rent, a period landlord has a luxury of a reliable long-term tenant who covers all the costs for maintenance.
In case, if the tenant refuses to buy the house, the landlord gets to keep the option fee or funds saved on the escrow account. The rent-to-own arrangement also has significant tax advantages.
However, the downside of this arrangement is that it is unilateral. The landlord is obligated by the terms of the lease to sell the property to the tenant, while the tenant is not obligated to buy the house.
In such a way, the landlord is bound by the agreement and cannot deal with any third parties. This significantly limits the financial flexibility, the landlords cannot renegotiate the terms if the market rise or sell for the lump sum if he/she suddenly needs funds.