If you're ready to buy the home of your dreams, but your credit or savings isn't quite ready yet, a lease with option to buy (often simply called a "lease option" or, somewhat inaccurately, "rent to own") may help you move in. Lease options, in which you lease (rent) a property and have the option to buy the property at the end of the lease term, can allow you to control a home that you want even if you don't have enough money for a down payment yet. A lease option may also be helpful if you need some time to improve your credit before you can get a good mortgage rate.
Lease options can be useful home-buying tools, but they're not for everybody. In fact, the majority of lease options do not end with the lessee (the renter or prospective buyer) purchasing the home, and while that's sometimes for a good reason, it's often just a waste of money. Ask yourself a few questions before you decide to pursue a lease option in general or before you sign one on a particular house.
1. Can you afford the option money? The option money or option fee is required for a lease option contract to be valid. This upfront payment may be 3-5% of the purchase price. All of this money should go toward the purchase price or down payment on the home if you decide to buy the house at the end of the lease term, but unlike a security deposit, you don't get the option money back at the end of the lease if you can't purchase the house or decide not to.
2. Do you plan to stay in the area? Since a lease option typically costs more than simply renting, you should be fairly certain that you want to buy the house at the end of the term. If you don't, you lose your upfront option money and any additional money in excess of the fair rental value that you've paid in your monthly payments.
3. Will you be able to secure financing at the end of the lease term? A lease option can help you get a more favorable loan than you otherwise would be able to, but it's no guarantee, so you'll want to be reasonably sure that you'll be able to qualify for a loan at the end of the term. Check with a loan officer to examine your situation.
4. Can you afford the monthly payments on the lease? Typically (but not always) the monthly payments on a lease will include the fair rental value ''plus'' option money that will go toward the purchase of the home. Thus, the monthly payments under a lease option will usually be more than you would pay if you were renting the same house.
5. Will you be able to make the monthly payments on the home and meet other expenses of ownership? Even if you're able to get the loan, it won't do you any good if you can't afford to keep up with the expenses of owning the home. Be sure to factor in not only the mortgage payments, but also property taxes, insurance, and maintenance costs, all of which renters don't have to pay.
6. Find a house you want to buy. Keeping the above considerations in mind, look for a house that you like and that you can afford. There are some companies that specialize in lease options, and have investors who will buy a house for you and then offer you a lease option. More typically, you can just find a house for sale and see if the owner will consider a lease option. You or your real estate agent may be able to convince the seller to work with you.
7. Negotiate the terms of the lease option. The purchase price, term of the lease (usually anywhere from 12-36 months), the amount of initial option money, and the amount of the monthly payments that will go toward the purchase price will all be negotiable. While you can find lease option contracts online, it's best to get one from a local real estate agent or attorney, since laws concerning lease options vary from state to state, and there may even be local regulations. A real estate agent or attorney can help you draft the contract and negotiate the terms, and it's important for both the buyer and the seller (lessee and lessor) that the contract be well written.
8. Pay an option fee and sign the contract. The option fee is the upfront "consideration" that is necessary to make the contract binding. Pay this and sign the contract only once you are sure you understand all the terms of the agreement and you agree with them. In many cases, the lease option contract will be a seperate contract from the lease agreement.
9. Make monthly payments. You will make monthly payments just as you would make rent payments. In many cases, however, a portion of the monthly payment will be designated as option money. Again, however, the option money will generally be over and above the fair rental value, so the monthly payments will be more than they would be to rent the same house.
10. Make improvements on the home. If the home inspection turned up minor problems, or if the home needs a little remodeling or cosmetic care, it is probably in your best interest to try to take care of these things. By increasing the value of the home with improvements during the lease term, you earn equity (so-called "sweat equity") in the home because the agreed-upon purchase price stays the same. This increased equity may help you get a more favorable loan if you exercise your option to buy. In essence, by increasing the value of the home you are increasing your down payment.
11. Apply for a loan. Don't wait until the last minute to apply for a loan. You should begin your application process in advance of the end of the lease, and to be safe you should probably start a full two months or more before you need to buy the house.
12. Close on the home. If you've lined up your financing and decided to exercise your option to buy at the end of the lease, congratulations. You are now a homeowner.