Renters who are monitoring local home prices and interest rates may be eager to buy, but their credit history, lack of savings or employment history may keep them from qualifying for a home loan. Other renters may be reluctant to buy now, fearing that home prices have not yet hit bottom.
Homeowners who have been unable to sell their home — or who are waiting for prices to rebound — may have become unwilling landlords because they are out of options.
A lease-to-own arrangement offers a solution for both renters and homeowners who find themselves “stuck” in the current housing market.
Lease-to-own arrangements can be complex and require the assistance of an attorney or at least a real estate agent experienced with this type of transaction. In any case, both the sellers and the buyers need to fully understand the financial implications of a rent-to-own contract.
“When I shepherd people through the lease-to-own process, I find that many buyers choose not to do it when they realize that the arrangement is 100 percent different than what they thought it would be,” says Gerry Dunn, an associate broker with Weichert, Realtors in Potomac. “People sometimes think that if they rent a home for $2,000 per month and set a settlement date in two years that they will have accumulated a $48,000 credit for a down payment. But when rent-to-own buyers apply for a loan, the lender will only allow a credit for the amount of rent paid above the market rate for rentals. No landlord or lender would accept the entire month’s rent as a credit toward buying the home.”
As long as renters understand the rules of lease-to-own arrangements, there can be some advantages for them.
“Typically, renters who choose a rent-to-own contract either don’t have the down payment money, have debt to pay down or have credit issues that need to be resolved before they can qualify for a loan,” says Alisa Sampedro, a Realtor with Coldwell Banker Residential Brokerage in Leesburg. “Buyers are able to lock in the price and the terms of the property they want to buy and receive a rent credit during the time they are renting the home. Renters also have the advantage of ’trying out’ the house before they buy it.”
Mrs. Sampedro, a real estate investor as well as a Realtor, has negotiated multiple lease-to-own contracts for her own properties and for both buyers and sellers.
“I typically arrange for a significant rent credit so that buyers become accustomed to the monthly payment they will be making when they take on a mortgage for the home,” says Mrs. Sampedro. “For example, if a home has a market rate rent of $1,750, I will have the renters pay $2,100 per month and credit them as much as $500 each month so they can make a little money from the arrangement. That way, they actually have a significant credit when the lease ends in two or three years.”
Mrs. Sampedro says that each lease-to-own contract is negotiable and should meet the needs of both buyers and sellers. She says while rent credits are expected, they are not required. She recommends that renters write separate checks for the market rent and the additional rent so that the credits are transparent at the end of the lease. Another option is for renters to make an option-to-buy deposit, which allows them to buy the home at a specific price at a specific time.
“I recommend that the renters meet with a mortgage lender at the beginning of the lease-to-own agreement so that they can understand what it will take for them to qualify for a loan, such as cleaning up their credit or saving more money for a down payment,” says Mrs. Sampedro. “Buyers need to understand everything about the agreement so they are prepared for every possibility.”
Most importantly, buyers need to realize that if they choose not to buy the home at the end of the lease, they will not be given a “refund” of the money they have accumulated toward the purchase of the home. The money will only be returned to the renters in the form of a credit at settlement when they buy the property.
“A lease-to-own arrangement can work well for people who are comfortable in the property where they live and would like to buy it,” says Mr. Dunn. “They also need to be confident that their income is going up so they can qualify for the loan when the settlement date arrives, and confident that the home will appreciate or maintain its value. A good example for this scenario would be a family that wants to move into a particular school district but cannot afford it yet, or a recent college or law school graduate with the potential for increasing income.”
Buyers have the advantage of locking in the price of the home at the time of the lease, which has the potential of allowing them to purchase it at a below-market price in two or three years.
For sellers, the advantages in this current market are to have a ready-made buyer in place and to have a long-term renter to help maintain their cash flow, particularly if the renters are paying an above-market rent in order to accumulate a credit toward buying the property.
“If homeowners are having trouble selling their home, offering a lease-to-buy option can be a way of increasing the pool of potential buyers,” says Mrs. Sampedro. “Also, it can be a big benefit to have a buyer with an ’owner mentality.’ In other words, while the vast majority of renters take good care of a home, someone who intends to buy it will take even greater care of it.”
Sellers take on the risk that the buyers may opt out of buying the home at the end of the lease and then the property must be placed on the market or rented again. Additionally, the home price must be set at the time of the lease-to-own agreement, so if prices rise dramatically, the seller may have lost potential profits.
For example, if a home is currently valued at $200,000, the seller and renter may agree on a price of $230,000 in three years to account for appreciation. If prices increase faster, the home could be worth $250,000 in three years. The seller would simply lose out on that appreciation. If the home drops in value during the lease-to-own period, the buyers have the option of not buying it or renegotiating the price if the sellers are willing.
“The main protection for the sellers in a lease-to-own arrangement is that they accumulate the rent credit during the lease period,” says Mrs. Sampedro. “If the renters choose not to buy the home, the homeowners keep the credit.”
If the renters do buy, their additional payments are returned as a credit to the buyer on the settlement sheet and can be used as the earnest money deposit, down payment or for closing costs. The sellers do not need to provide the credit as a cash payment.
Another issue to be negotiated at the time of the lease-to-own agreement is maintenance. While the property is still owned by the sellers, some landlords arrange for the tenants to take on some routine repairs and maintenance. Mrs. Sampedro says that each side should make sure they understand what is in the written agreement about maintenance and other issues.
Renters interested in finding a lease-to-own option can work with a real estate agent and search online on sites such as Craigslist.com.
“Renters can look for a home that has been on the market for more than 180 days or in a neighborhood where the homes are not selling, since the sellers in those cases may be more willing to negotiate a lease-to-own arrangement,” says Mr. Dunn.
Mr. Dunn and Mrs. Sampedro recommend working with an attorney to negotiate the terms of the lease-to-own contract.
George Hawkins, an attorney with Peterson, Noll and Goodman PLC in Vienna, says, “Everything that could impact a lease-to-own contract needs to be in writing and both sides need to understand the agreement. Typically, a contract is structured for a seller who wants to sell the property to someone who lacks the funds, especially a down payment of 20 percent. The transaction is structured to take place over two to five years.”
Mr. Hawkins says that lease-to-own arrangements work particularly well for families who want to transition a home from the parents to the children over time.
“A lease-to-own arrangement does not work as well between strangers if there are trust issues over the maintenance of the property or other factors,” says Mr. Hawkins. “A lease-to-own contract that gives the tenant an option to buy the property on a certain date at a certain time basically amounts to seller financing, with the tenant accumulating a down payment during the time of the lease. The seller is receiving the deposit incrementally in advance of the settlement date.”
Mr. Hawkins says that the biggest risks concern how the money will be held by the sellers and under what conditions the sale will take place, all of which must be spelled out in the contract. The agreement must also address the specific issues of routine maintenance, repairs and home improvements.
“The lease-to-own agreement can be written essentially as an extremely long-term pre-occupancy agreement, but typically the landlord is still responsible for repairs and maintenance since the title is still in the landlord’s name,” Mr. Hawkins says.
Mr. Hawkins warns that the potential problem for the homeowners is that they must function as landlords and may still have to sell the home at a later date to another buyer.
“Buyers may be better off investing the extra rent money they are paying in order to accumulate a down payment, rather than paying it to the landlord,” says Mr. Hawkins. “However, locking in the price at today’s market value could be a smart decision.”
Not all lease-to-own arrangements are between individual buyers and sellers.
Kettler, which develops and manages both apartments and condominiums in the Washington area from tax credit-subsidized affordable homes to upscale luxury buildings, offers a “lease-to-buy” program for their renters. The company is careful to label this as a “lease-to-buy” opportunity, not “lease to own,” because the renters receive a credit to purchase a condominium in another Kettler development, not the apartment they are renting.
“We’ve had this same program since about 2005 that credits every renter with $250 per month up to $5,000 towards the purchase of a Kettler condominium,” says Karen Kossow, vice president of sales and marketing for Kettler. “This is a nice benefit to our renters and something they don’t even have to sign up for since it is automatic. The renters are not paying anything additional in rent either.”
Renters must use the credit within 60 days of moving from a Kettler apartment into a Kettler condominium and they cannot use a broker or real estate agent for the condominium purchase.
“We opted to use a flat rate for the credit since we have homes in every price range,” says Ms. Kossow. “Interestingly, the people who have used the credit have come from both our market-rate homes and our affordable homes. It can be a big help to someone moving from a tax-subsidized home who has worked hard to improve their finances.”
Note that Kettler’s lease-to-buy program does not involve any cost or risk to buyers since they are not paying additional rent to participate, but typical rent-to-own contracts require the renters to pay above market rent to accumulate money for a credit for their down payment or closing costs.
Like any other real estate transaction, lease-to-own contracts should carry a “buyer beware” stipulation, but sellers should be equally certain they understand the ramifications of agreeing to take their home off the market and set a price for a future sale.
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