Rent-to-own contracts appeal to prospective first-time home buyers who need more time to build up their credit scores or save for a down payment. Lease purchase agreements are arguably the most legally binding of the various lease-to-own options.
Learn what’s at stake and if it’s the right option for you with our in-depth breakdown of a lease purchase agreement and its benefits.
A lease purchase agreement in real estate is a rent-to-own contract between a tenant and a landlord for the tenant to purchase the property at a later point. The renter pays the seller an upfront option fee based on the purchase price, giving them exclusive rights to buy the property.
Both parties agree to what the purchase price of the home will be at the end of the lease term. The agreement will likely include a stipulation that a portion of the monthly rent goes toward a down payment. The renter should be confident that they can secure a mortgage at the end of the lease or else they forfeit the purchase option.
Lease purchase agreements are often confused with lease option agreements because they both share that crucial, nonrefundable option fee. Both prohibit the landlord from selling the property to anyone else during the lease term and give the tenant the option to purchase at the end. In that sense, they’re both rent-to-own agreements.
The difference between a lease purchase agreement and a lease option agreement is that the lease option only obligates the seller to sell. A lease purchase agreement commits both parties to the sale barring breach of contract or the buyer’s inability to secure a mortgage. Buyers are also typically required to pay for maintenance costs, property taxes and insurance and can expect to pay higher than fair market rent to contribute to a down payment.
Lease purchase agreements often include two distinct contracts: one for the lease agreement and the other for the end-of-lease sale. These two different contracts will include cross-default provisions that make certain clauses mutually exclusive. That is, if you breach one provision, such as missing a monthly payment, it may trigger an automatic breach in the purchase contract.
The lease should outline how long the lease period will be and the monthly rent amount. Lease purchase agreements will often have a longer period of time for the lease, typically up to 3 years.
The lease agreement will include all the standard elements of a traditional lease along with a few special clauses, such as requiring the tenant/buyer to pay for maintenance costs, property taxes and insurance fees.
Some common special clauses to look out for include the option fee amount, purchase price and down payment. Both parties will agree to an option fee, which legally binds the landlord to sell the property to the tenant at the end of the lease even if the landlord or tenant changes their mind. Such an agreement comes at a cost. The option fee can be any amount and is nonrefundable.
This portion of the agreement will also typically allocate a dollar amount of rent that’ll go toward a down payment. Let’s say a renter is paying $2,000 a month on a $250,000 home, and $400 per month goes toward a down payment. At the end of a 24-month lease, the buyer has the option to use $9,600 as a down payment of 3.8%, just above the minimum for most mortgages. If the buyer decides the house isn’t for them and backs out of the sale, they forfeit the down payment.
This section will outline the purchasing process and terms once the end of the lease period has arrived. No matter how long the lease term is, both parties will agree on a purchasing price (based on fair market value) at the time of the rental agreement. Often, the purchasing price will be higher than the market value to account for appreciation. No matter which direction the market fluctuates, both parties are bound to this agreed-upon purchasing price.
The buyer will be responsible for securing a mortgage loan on the property. If the tenant was unable to qualify for a mortgage before signing a lease purchase contract, they’d be able to share their agreed-upon down payment timetable with the lender as leverage for a better deal. At the end of the residential lease, the lender will send the funds to the seller to transfer the title.
It’s highly recommended to have a real estate attorney review this type of agreement before you sign it. While most often the agreements will nullify the contract of sale if the buyer can’t secure financing, some will require full repayment whether you can afford to or not. That’s why it’s usually a good idea to seek legal advice when entering into any kind of real estate purchase agreement.