How Does Rent To Own Work?

By Jay White

June 7, 2015   •   Fact checked by Dumb Little Man

In the United States, financing the acquisition of residential real estate almost always involves taking out a mortgage. It is not uncommon for American home buyers to go through various mortgages throughout their lifetimes and never consider alternative methods of real estate financing such as rent-to-own.

Few home buyers consider rent-to-own contracts because of the great influence that the mortgage market has on the real estate industry of the U.S. Lease purchase or lease option contracts put off closing on a mortgage for a while, and this is not in the best interest of the home lending industry.

It is important to note that rent-to-own contracts in the U.S. are not like owner-financing arrangements in Europe and Latin America, whereby sellers act as mortgage bankers and collect payments from the buyers, who may also be tenants. Rent-to-own contracts in the U.S. essentially allow home shoppers to buy time before closing. The reasons for not closing right away may be related to special needs or a market strategy.

A lease option contract gives the tenant the right of first refusal for purchasing a property down the line. This is not exactly an agreement to buy; however, the tenant may be able to negotiate a better price and more favorable conditions at closing. Tenants in lease option arrangements essentially pay for the right to enjoy the property before closing and to get a better position in relation to other potential buyers, but the contract does not push tenants into acquisitions.

A lease purchase contract ensures that tenants will purchase the property in the future at a price that is agreed when the agreement is executed. In this fashion, a rent-to-own arrangement allows the buyer to come up with a down payment, secure mortgage financing, enjoy the property as a tenant, get to know the neighborhood, and perhaps even get a nice injection of equity at closing.

Sellers in rent-to-own contracts get the benefit of being able to offer an attractive option in a buyer’s market. Lease-to-own contracts are more likely to be offered when there is an oversupply of homes and declining home values. Some property investors may be attracted to rent-to-own arrangements if they feel that they can effectively freeze the purchase price and take advantage of value appreciation down the line.

Drafting and negotiating equitable contracts is a must in rent-to-own agreements. All conditions and contingencies must be clearly defined since this is a real estate transaction that presents many variables and what-if situations.

Jay White

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