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How a Lease or Rent to Own Agreement Works

written by: Tim Plaehn•edited by: Jean Scheid•updated: 8/8/2010

You may be wondering what is a lease to purchase house agreement and will it help you buy a home. Read further to find out how a rent to own agreement may allow you to purchase a home.

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    Purpose of Lease to Own

    House Morgue File When considering what is a lease to purchase house agreement, it's basically a lease or rental contract on a home with an option to buy the home, usually within the first one to three years. The person renting the home signs a rent to own house agreement and is a renter until he exercises the option to buy the home. The homeowner is the landlord during the lease period and becomes the seller if the renter elects to exercise the purchase option.

    Lease to own agreements are designed to provide both sides of the contract with some incentives outside of the typical rental contract or outright sale and purchase of the home. Jack Guttentag. professor of finance emeritus at the Wharton School of the University of Pennsylvania and the online Mortgage Professor, noted in a recent Washington Post article that the reader interest in his "lease-to-own" online article was receiving a high level of interest in these times of difficult home sales and reduced credit scores.

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    Features of Lease to Own Agreements

    A rent to own house agreement is structured to allow the renter/buyer to build up some equity in the home before it is actually purchased. In most rent to own agreements, the renter pays and an upfront deposit to enter the agreement. If the renter elects to buy the home, the deposit is credited toward the price. Also, a portion of each rental payment accrues as additional down payment against the purchase price of the home.

    The purchase price of the home is set in the lease to own contract. The renter can elect to buy the home at the purchase price at any time until the lease contract ends. Lease to own contracts typically have terms of one to three years. If the renter elects not to buy the home, he forfeits the original deposit and any of the rent payments that were credited toward the purchase price.

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    Benefits of Lease to Own

    For prospective buyers, a rent to own a house agreement allows them to lock in the price of a home and build equity in the home before attempting to obtain a mortgage on the house. This type of arrangement often works for buyers who are rebuilding their credit or don't have enough money to place a down payment on a home purchase. The renter also gets to try out the house before the actual purchase and build a history of prompt payments. These factors can make it easier to qualify for a mortgage.

    For the seller, renting to own is another way to sell a home in a difficult market. Using a rent to own agreement may allow the seller to get a better price for the house and the seller will receive rental income until the sale is finalized. Home investors with several properties can use rent to own contracts as a way to generate income from the properties and eventually sell them at profitable prices.

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    Warnings and Considerations

    If you are considering what is a lease to purchase a house agreement, keep in mind that rent to own contracts are not regulated by the government. It's a good idea for someone considering a rent to own contract to hire a lawyer to review the contract. Sellers in a rent to own contracts may look for a way to break the contract if the home goes up significantly in value. The renter must be sure to make all payments on time and follow the requirements of the contract to protect his equity in the home and the rent to own contract. The renter must also be aware that he must be able to qualify for a mortgage to complete the purchase option of the lease to own or he will forfeit all of the equity that builds up from deposits and home appreciation.

    The article, 5 Reasons to Buy a Home, may be useful in deciding if a home purchase using rent to own agreement makes sense for you.

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    Resources

    1. Washington Post: Jack Guttentag (5/22/10) - (http://www.washingtonpost.com/wp-dyn/content/article/2010/05/21/AR2010052100131.html)
    2. Investopedia: Robert Stammers, CFA (accessed 8/1/10) - (http://www.investopedia.com/articles/mortgages-real-estate/09/real-estate-purchase-options.asp)

    Image Credit: House (Morgue File)