What to know before jumping into a rent-to-own lease
You can sometimes avoid a down payment, but watch it, they're complex
By Gary Foreman
The New Frugal You
Dear New Frugal You,
We would like to buy a house but don't have a down payment
saved up. Friends say that there's something called a "lease option"
that's like "renting to own" household furnishings. Is that really possible?
How do they work? How do you set a price? Would we need a lawyer? -- Adriana
Yes, renting or leasing
with an option to buy is a common transaction, but it is more complicated than
a lease or a standard home purchase agreement. So you'll have more things to
consider than if you were either a renting or purchasing.
With rent-to-own, the rental part of teh deal is just like any other
rental. But, as part of the contract, you have the option to buy it during the
The purchase price of the home is negotiated upfront and
stated in the lease agreement. Look at the property as if you were buying it
outright. That means getting a qualified inspection and appraisal before you
sign a lease. Bargain just as hard as if you were buying the home outright.
Don't assume that you can lease/purchase without a down
payment. Some contracts, including homes that are seller financed, do require a
down payment when the purchase option is exercised. And, as with other home
mortgages, the amount of the down payment is negotiated between the lender and
Expect to pay more each month than if you were simply
renting. Typically part of your monthly payment will either contribute to the
down payment or be the price you pay to have an option on the property.
If you are making a monthly down payment, write two checks, one for rent and the other for down payment. You want to have a paper trail that
demonstrates how much you've contributed toward the down payment. The bank
will want to know.
Plan on keeping detailed records of every financial
transaction. -- not only your rent and down payment checks, but any other
household expenses that you have. Until you apply for the mortgage, you don't
know what information the loan officer will want.
Your question presumes that the seller will carry the
mortgage. That's not always true. And finding a mortgage on a lease/purchase
can be tricky.
If the seller isn't going to finance, you'll need to do some
research on mortgages before you sign the agreement. Make sure that you're
reasonably sure to qualify for a mortgage when the time comes to complete the
You'll want an experienced real estate attorney to draw up
or review the contract. Tell them what you want to accomplish and let the attorney
choose the right documents. There are a number of different ways to legally set
up a lease with option to buy. The documents you choose may have tax
consequences or affect your ability to get the mortgage you want. This is
no place for do-it-yourself legal work!
Make sure your attorney talks you through the various
outcomes. Among the things you'll need to know are: what will happen if you decide to buy the home; the
effects of not renewing your lease; and what happens if you need to
break the lease.
As of mid-2013, the housing market is on an upswing, but be prepared for the housing market to fluctuate. Since 2008
we're all painfully aware that housing prices can go down, too. You could find
that your option price is more than the house is worth in a few years.
Consider, too, that you might not be ready to own a home.
It's natural to not want to wait while you save a down payment. But there's a
reason that lenders want a down payment. The time you take to save it could be
well spent if you use it to strengthen your finances and improve your credit
Your friends may be right. A lease/option could be a good
way for you to get your dream home without a down payment. But it does have
drawbacks that you need to consider before you make any commitment.
See related: A primer on rent-to-own arrangments
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Published: July 13, 2013