A Buyer’s Guide to Rent to Own Homes

Share:

In 2005 I became a landlord. A good friend and I began investing in single family homes in the mid-west. We purchased two HUD foreclosures in 2005, and since then we’ve added 3 more HUD foreclosures to our portfolio. When we advertise one of our homes for rent, we always advertise the property as a rent to own home. Also called a lease option, we structure the agreement to allow the tenants to purchase the home within a specified period of time for a set price.

[Looking to buy or refinance a home? Check out today's mortgage rates.]

We’ve entered into several lease to own agreements with tenants, although we’ve yet to sell one of the homes to a tenant (more about that in a minute). This experience has taught me two things: (1) tenants make major mistakes when entering into a lease purchase agreement; and (2) some landlords take advantage of tenants who don’t understand how to approach a contract for a rent to own house. Because rent to own real estate is becoming more and more common, this article will provide prospective tenants with tips on how to negotiate a fair lease option with a potential landlord. The article will also identify potential traps you should watch out for.

Here are the topics we will cover:

  • Lease Options 101: A summary of a lease option and points to consider when deciding whether a rent to own home is right for you.
  • Treat a Lease Option Like a Purchase: Although there is no obligation to purchase a home during the term of the option, tenants should enter the deal as if they are buying a home.
  • Key Lease Option Terms: A review of the following key terms–
    • Rental Agreement
    • Lease Option Fee (the 1% rule)
    • Term
    • Rent Credit (the 15% rule)
    • Maintenance Obligations
    • Purchase Price
  • Financing a Rent to Own Purchase
  • $8,000 Tax Credit

Lease Options 101

A lease option, lease purchase, or rent to own home involves two agreements, a rental agreement and an option to purchase the property. The rental agreement in most respects is a standard landlord-tenant agreement to rent the property at an agreed price for an agreed term. The option gives the tenant the right to purchase the property within an agreed upon time (typically one to three years) at an agreed price.

There are several reasons why a lease option may be an attractive way to buy a home. First, lease options appeal to those who do not have enough for a down payment. Through rent credits (see below), a tenant can accumulate cash that goes toward the down payment. In addition, during the rental period, the tenant can save money above and beyond the rent credit to put toward the house. Second, for those who have a low credit score, they can work to improve their FICO score during the term of the rent. And finally, a rent to own home gives tenants an opportunity to live in the home and get to know neighbors before committing to the purchase.

Of course, you don’t have to rent a home with an option to buy to accomplish all of this. You can just rent a home in a neighborhood that interests you, save a down payment while you rent, and work to repair your credit score. But for those who do enter into a lease purchase, the above reasons are generally why.

Treat a Lease Purchase Like You’re Buying the Home

Before we look at the key terms, there is one very important consideration to keep in mind. You should treat a lease purchase property as if you are buying the home. It amazes me how some people will put down a lease option fee and enter into a 3 year contract having spent 10 minutes in the home. Almost without fail these people do not exercise the option to buy the home, instead moving on to another lease option deal somewhere else. The goal of a lease purchase should be that you eventually buy the home. While intervening events may cause you not to exercise the option, you should treat the transaction as if you will. So what does this mean?

First, you should inspect the home as you would with a purchase. Whether you hire a home inspector, have a friend or family member look at the home, or inspect the home yourself, you should look over the home as if you were going to sign a purchase agreement. Second, look for a home you actually want to own. Often tenants enter into a lease purchase agreement because the home happens to be available, not because it’s a home they truly want to own. And finally, negotiate all the terms of the deal as if it were a purchase. And with that, let’s look at the key terms of a lease option.

Key Lease Option Terms

Rental Agreement

A lease option is first and foremost a rental agreement. The key terms in any rental agreement are the rent and the term. In these deals, however, there are two key points to remember. First, the rent should be whatever reasonable market rent the home justifies. The rent should not be higher because of the lease option component of the deal. Remember, you’ll be paying an option fee which covers the value of your right to purchase the home. The rent is the rent. I’ve heard horror stories of tenants agreeing to outrageous rents because the landlord convinced them it was justified in light of the lease option.

Second, the term of the option should give you enough time to save up a down payment and repair your credit. If you know this will take two or three years, a one year option is a waste of time and money. If you are not sure how long it will take you to qualify for a loan, talk to a mortgage broker before entering the deal. They should be able to give you some idea of how long it will take to get your finances in order to qualify for a home mortgage. Generally, terms of two to three years are common for rent to own single family homes, at least they are where we invest.

Lease Option Fee (the 1% rule)

The lease option fee is the cost of the option to purchase the home. The option lasts for the length of the rental term, typically. In other words, if the rental term is three years, the option gives you the right, but not the obligation, to purchase the home anytime during those three years. When you negotiate the option fee, keep three key factors in mind:

  • The amount of the option fee (about 1% of purchase price)
  • Whether the fee is refundable (generally no)
  • Whether the fee applies to the purchase of the home (generally yes)

First, of course, is the amount of the fee. As a rule of thumb, 1% of the purchase price of the home is reasonable. The homes we rent range in value from about $130,000 to $175,000. The option fees we charge generally range between $1,450 and $1,950, which is slightly higher than 1%. However, we do not require tenants to put down a security deposit on a lease purchase deal. I’ve seen landlords ask for and get option fees as high as 5%. I suppose if they can get it, why not ask. But as a tenant, 5% is just too high in most cases. If a property owner is asking for 5%, negotiate or keep looking.

Second, recognize that option fees are non-refundable. If you don’t buy the home, the landlord still keeps the fee. In this way, a lease option for a home is similar to an option contract on a stock. The cost of the option is not refundable even if you chose not to exercise the option. As a result, you should think carefully through the transaction and whether you really want to purchase the home and whether you’ll have the financial means to do so during the term of the option.

Finally, make sure that the fee will go toward your down payment if you exercise the option to buy. While this is typical in my experience, you may find some landlords who seek to treat some or all of the option fee differently.

Rent Credit

In most lease purchase arrangements, the tenant receives a credit that will go toward the purchase price if they buy the property. While there is no universally agreed upon amount, for residential real estate, 10% to 15% of the monthly rent seems to be a good rule of thumb. For a home costing $1,295 a month, for example, we offer a monthly rent credit of about $150. The rent credit is an important part of the deal for tenants for at least two reasons.

First, it of course reduces the cost of the home when you exercise the option. And second, it can help you build up a down payment on the home. The key is to make sure that the deal includes a fair rent credit. Finally, we make the rent credit contingent on timely rent payments. If rent is late one month, the tenant loses the rent credit for that month.

Maintenance Obligations

Recently, we’ve started shifting the maintenance obligations over to the tenant. This practice is not uncommon, particular with land contracts or rent to own arrangements. From a tenant’s perspective, taking on the responsibility of maintaining the property may seem like an unwanted financial risk, and to some extent it is. There are, however, some potential tax benefits of taking on this obligation (see below).

If you do find a landlord that wants you to assume the maintenance obligations and you’re willing to accept this responsibility, here’s a tip. Instead of taking on this responsibility on day one, consider delaying the transfer for six months. This gives you a chance to identify any latent issues with the home and to get them repaired on the landlord’s dime. In effect, this gives you a six month warranty on the home.

Purchase Price

There are two big mistakes that many tenants make on the purchase price. First, they don’t negotiate for a lower price. And second, the enter into option to buy deals where the price is not fixed.

Since we began offering our homes on a lease purchase, not a single tenant has even tried to negotiate the purchase price. This is a big mistake. The purchase price is always negotiable on a lease purchase deal, just as if you were buying the home outright. It’s easy to research home values on the Internet. Begin with online home value websites to get a rough guide. And then look at comparable homes that have sold in the last six months. Armed with this information, negotiate a fair price.

And whatever price you agree upon, it should be fixed during the term of the option. Avoid deals where the purchase price will be “agreed upon” later or based on some future appraisal. The option fee is paid in exchange for the right to purchase the home for a set price within an agreed upon period of time. If a landlord won’t agree to a fixed price that is fair, look for another property.

Financing a Rent to Own Purchase

It may seem odd to talk about financing since you won’t need a mortgage unless and until you decide to buy. But my recommendation is that you talk to a mortgage broker BEFORE entering into a lease option. A good mortgage broker will give you an honest assessment of your chances of being approved for a loan during the term of the option. While a broker can’t offer you any guarantees, they can arm you with important information that will help you make the best decisions for you and your family.

$8,000 Tax Credit

As you may know, first time home buyers may qualify for a $8,000 tax credit if they purchase a home in 2009. In addition, a bill has been introduced to extend this tax credit beyond 2009. In the context of a rent to own house, the question arises whether you can qualify for the $8,000 credit in 2009, even if you haven’t yet exercised the option to buy. The short answer is yes, under certain circumstances a lease option transaction may qualify you for this tax credit. Of course, you want to check with a tax specialist before making any decisions.

Here’s a Q & A from the IRS on this topic:

Q. Can a taxpayer claim the first-time homebuyer credit if the purchase is pursuant to a seller financing arrangement (for example, a contract for deed, installment land sale contract, or long-term land contract), and the seller retains legal title to secure the taxpayer’s payment obligations?

A. If the taxpayer obtains the “benefits and burdens” of ownership of a residence in a seller financing arrangement, then the taxpayer can claim the credit even though the seller retains legal title. Factors that indicate that a taxpayer has the benefits and burdens of ownership include: 1. the right of possession, 2. the right to obtain legal title upon full payment of the purchase price, 3. the right to construct improvements, 4. the obligation to pay property taxes, 5. the risk of loss, 6. the responsibility to insure the property and 7. the duty to maintain the property. (New 7/2/09)

You’ll notice that #7 is the duty to maintain the property, which brings us back to the transfer of maintenance obligations. Of course, that’s just one element the IRS considers, and as I noted earlier, you should consult with a tax specialist if you are considering a lease purchase and the $8,000 tax credit. And keep in mind that qualifying you for the tax credit may require entering into a land contract rather than a lease purchase.

A lease purchase can be a reasonable way to purchase a home. Particularly if you’ve recently been through a bankruptcy, have bad credit, or lack enough cash for a down payment, a rent to own home may be a good option. If you’ve ever purchased a home this way, please share your experience in the comments below. And if you have additional tips, please share those, too.

Published or Updated: July 25, 2010
About Rob Berger

Rob founded the Dough Roller in 2007. A litigation attorney in the securities industry, he lives in Northern Virginia with his wife, their two teenagers, and the family mascot, a shih tzu named Sophie.

Comments

  1. Ankur says:

    Thank you so much for sharing this article. Great article, great content

  2. Manshu says:

    Thank you for another detailed and in depth article.

  3. Christie says:

    Thank you for posting this article. Very informing!

  4. La Toya Brown says:

    Thank you for sharing a wealth of knowledge from your point-of-view. It was extremely helpful.

  5. Kaye Swain says:

    Very interesting article and info on rent to own. We considered this when we were younger and this info would have been a huge help. :)

  6. Maria says:

    We recently purchased a new home, which we haven’t moved into yet. Our current home has no mortgage or liens on it and my daughter is interested in purchasing it. She already owns several rental properties, therefore cannot be approved for another mortgage. We are weighing the option of her leasing/renting it to own, but we’re afraid we will end up paying a large amount of taxes since her rent would be considered income for us. What would be the best way to go about leasing this to her for up to 30 yrs or until she’s able to pay it off….whichever comes first – without us taking a huge hit financially?

    • DR says:

      Maria, while there will be some expenses you can deduct from the income you receive (such as depreciation), you likely will end up paying taxes on some portion of the rent. One option is to sell her the house and finance it yourself. By selling the house, you take advantage of homeowner tax breaks. You’ll pay taxes on the interest portion of the payments, but not the principal. But before you make any decisions, talk to a tax professional. Best of luck.

  7. Sandy says:

    Excellent!! Thanks. This article has met my needs today.

  8. Ari says:

    Hi! I was wondering if you could talk a little bit more about the tax consequences for the sellers in a lease-buy option. We rented out our home with an option to buy, and $200 of the monthly rent will be applied to the purchase price. Do we still count those $200 as part of income for this year, or is that applied as income only in they year that they do not exercise the option? Thanks!

  9. Tasha says:

    what do you do when you have moved into your rent to own home three weeks before the actual move in date , courstey of the morgage co and day one the ac is not working, the home was not inslated, pipes making strange noise when running water. The Morgage company / home ownwers not wanting to repair nothing . My contract hv not started yet , . How do I get out of the half ass rehabed home.

  10. TOM says:

    who would i talk too about having someone leasting my home with an option of the person to buy it, she is trying to get her credit score up to buy my home. not sure who too talk too, bank, finciance person. thanks tom

    • Tom, our company specializes in these types of transactions. Feel free to give me a call at 703-728-2663 and I can walk you through the key things you need to be aware of.

  11. DR says:

    Tom, I’d say your best bet is to talk to a realtor. Since you already have a potential renter, however, you don’t want to hire a realtor and pay the fee. But an agent should be able to walk you through the process and perhaps even provide you with some standard forms.

    • David Watson says:

      Wrong answer, with all due respect, a Realtor is least qualified to answer this question. The education an agent receives is typically one paragraph out of a very big book (Modern RE Practice 7th ed – Dearborn Publishing). Further the reason Rent-to-Own has a poor reputation in the traditional real estate circles, is that most do fail. Our local association’s counselor Michael Lafayette stood up in front of a 3 hour Lease Purchase class and prefaced by saying he would rather do a short sale then a Lease Purchase/Option. Realtors have no training on how to qualify, structure, and execute a lease option. Most states, including Virginia, have NO standard forms. I’ve spent thousands (as a KW agent) on education, contract review and continue to train on this niche business model. It is a model that does not work for everyone but can be a real win/win when it does.

  12. mike says:

    4 months ago my family moved into a home that we signed a contract on that says we will rent the home and purchase for an agreed price in 8 yrs or sooner. The owner of the home has a mortgage on it and they pay the mortgage, taxes, and homeowners insurance with the money that we pay each month, until we purchase it. State Farm insurance just dropped the homeowners policy because our contract together reads as a purchase. So the home owner has called around quotes on home and all too high, she wants to stay with state farm and the only way state farm will insure the home is if she gives them just a rental agreement from us. We have been asked to sign a generic rental agreement so she can give it to them. I dont understand, if she is the mortgage holder than it shouldnt matter, the mortgage holder pays the homes insurance right? Any advice? Thanks

  13. While rent to own is a viable option, I would urge potential home buyers that are unable to obtain traditional financing to consider buying a home on seller financing using a contract for deed. The main advantage being that they will get all the tax advantages of home ownership from day one since they have equitable title to the property.

    We have many homes available on our site with very attractive seller financing terms.

  14. Mark says:

    I am currently going to go into a rent to own agreement with the owner of the house that I have been renting for 2 yrs. She needed money for an operation of her sick father. She contacted me and told me that if I was interested in purchasing the home from her. I said that I was interested and she explained her situation of having to come up with her part for her dads surgery. She stated would leave mortgage under her name just wanted 3500.00 as down payment. She has since done that but mortgage company wanted her to purchase own insurance. She did purchase own insurance and all that good stuff. I am going to assume the payments on house, insurance, and taxes. I am wondering if I need to be included on the insurance for the house or should it just be her. She very honest and I don’t feel I would have any problem with her if anything happened to house. We are going to do this legally and sign papers to state that after the loan of the house is paid the house will pass into my name unless I can finance it under my name before hand. I read that rent to own or lease with option to buy might still qualify for the 8000.00 tax credit. Would I qualify if I assume all responsibility even though she has a mortgage on home?

    • Mark says:

      Sorry forgot the part where she refinanced house for lower payments that is why mortgage wanted her to purchase own insurance. She did not get any extra money out of refinancing just what was owed.

  15. nitro taylor says:

    1% option? And no security? It takes longer to remove a lease option renter. If they know they are not going to buy they will not pay last months rent and will stay until the court removes them. You are looking at 3 months unpaid rent plus damages. I charge $4,500 option incase of this. Only $150 a month? That’s only $1,800, what kind of incentive is this? I give them 50% of rent towards purchase, ($750×12=$9,000+$4500=$13,500), it helps them tremendously. Negotiate downward? Why? Owner is allowing interest free house payments, (50% rent), to a unqualified buyer; the price is usually on the high side. Where else can you pay $9,000 a year or more towards the principal and not the interest of a home purchase? Hold off on maintenance? The lease/buyer is responsible for all maintenance from day one; that is why money is being set aside for purchase and renter has all the tax benefits. Purchase within 12 months and not have to worry about repairs for 6 months, please tell me where I can get a deal like that. This is not a perfect world, and if they decide to move, owner is often stuck with unpaid rent and damages.

  16. Cindy says:

    Nice article and very informative. I wish I had read it a few years ago. I’m in a 3 year lease to own contract and the option to buy expires in a few months. The locked selling price is $250,000 after paying a down payment of $30,000 (the original price was negotiated at $280,000, so less the down payment up front). My monthly payments are $2400 and we are using a 30 year mortgage amortization chart with an 8% APR to determine what % of the monthly payment actually pays down the cost. Since the fallout of the housing market, the house will never sell for the price we agreed to in 2007. From research, it seems that similar homes in the area have been reduced by as much as $100,000.

    Although, I love the house, we will never be able to get it financed based on our leased contract. We are now forced with a very hard decision to either walk away now or continue to spend our hard earned money in an over-priced home.

  17. Ben says:

    We completed the first year of a Lease/Option contract home in Jan. 2011. Part of our payments go toward ownership, property taxes and insurance (defined in contract). We pay for maintenance and upkeep. From the information in the above article, it appears we will qualify for the home buyers tax credit. Does this make sense to you? Thanks a lot.

    • DR says:

      Ben the home buyers tax credit has expired.

  18. COLA says:

    DR., PLEASE HELP:…………….I would like to enter into a lease/option on a home i recently saw for rent, unfortunatley the rent payment is high and the home is up for sale at a alarmingly high rate, BUT i LOVE the home and would like to buy. The price tag is $339,000 (NEW CONSTRUCTION) and rent is listed @ $1800.00 monthly!!! it’s been for rent for a very long time. How can I get them to come down on the monthly rent to maybe $1500.00 given I put a higher down payment +Security deposit and enter into a lease/purchase contract that included a substantial down payment when time to purchase the home?

  19. Mike says:

    I currently have leased a home with the option to buy. In my lease it says I pay the property tax, which I have done. Even though I don’t own the home yet can I write the property tax off my taxes?

    • DR says:

      Mike, my best guess is no, because it would be treated as just part of the rent payment. The fact that it is designated as going to property tax doesn’t change that fact. But that is just a guess, and I’d suggest consulting a tax professional before filing your taxes.

  20. Shannon says:

    My father has a house that my husband and I are interested in purchasing, but won’t have the down payment. Although we do have excellent credit, we just want to pay off some other obligations before starting to save for a down payment. I know my dad would be open to other options, would you recommend the lease to own, my dad acting as the lender, or a installment land contract? Additionally, what type of outside party would we need to facilitate this, if any (i.e. real estate agent, attorney, etc.)?

    Another factor to consider is that because my husband has been overseas with the military, we could (and would love to) still qualify for the first time homebuyers credit if we complete our “purchase” by June. If we could qualify for that, then we would be able to have the down payment available by the time we received our 2011 tax return. Not sure if that would change your suggestion.

    Thank you for the informative article! By far the best I have found while researching this issue.

    • yoyo says:

      You are 1 year too late for the homebuyer tax credit.

  21. Angela says:

    We have a possible Lease to Own situation. The owner does not owe anything on his property and has retired and bought a property to move to accross the State.

    If they do not own on the property then this would put us in a better position because more money would go towards paying down our purchase price, I expect. What type of percentage would you expect or reccomend should go towards the down payment? What type of percentage would the owner fairly take, appreciation?

    Could a Seller Finance Contract Deed be a good option? I am a little confuse on how that would work.

    Thank you for your time!

  22. Tiffany says:

    I am in a situation where I was in a lease with option to buy home and the SELLER needed back into the home due to financial/legal difficulties. We were given a date they needed to be in by and told if we wanted to buy the house now we could if not then they needed back into the home. We were not in a position to buy the home at that time and had 2 more years left on the contract but agreed to move out (due to the selling price of the house compared to homes being sold around it was significantly higher) . In this situation what happens to the option money that we put down? Should it be refunded since they broke the contract?

  23. Bill says:

    DR -

    I have a client who would like to purchase a rental property and rent it out to their son. If they were to convert this into a rent-to-buy arrangement, what are the potential tax consequences?

    • DR says:

      Bill, the first thing I’d suggest is consulting a tax professional. I’m no tax expert. Having said that, the tax consequences depend on the terms of the deal. Is there an upfront payment to lock in the purchase price? Does a portion of the rent go to the down payment on an eventual purchase. I believe that the tax consequences ultimately will hit when the sale occurs, not during the rental period. But again, they should consult a tax accountant.

  24. Barb says:

    Hi, I really need some help, my husband and I had purchased a home in May of 2010, well we thought we were home owners, come to find out we are rent to own. The company we went through told us that we are first time homeowners and that we can receive the $8000.00 tax credit, we received this credit and gave it to the company. This did lower the purchase price of the home, but come to find out the deed is not in our name. My question is if we move do we have to pay back the whole $8000, are just a percentage of it?

    Help!!!!!!!!

  25. sue b says:

    Someone had asked this of me “when we are in a rent to own relationship with a landlord, with only a signed agreement between them and us, no attorney involved, and the paperwork cites that we are responsible to pay property taxes, should we not then be the ones reporting the property taxes on our taxes? the owner is.”

  26. MarK says:

    My husband and I were letting my sister and her husband rent to own our house. We do have a mortgage on it. I know we made a big mistake by not drawing up a written contract….it’s all been verbal. The mortgage payment consisted of the monthly mortgage payment, property tax & homeowners insurance. They have lived there for 2 yrs and for the past year have had a dispute with the neighbors and because we don’t want to be involved our family members decided they are moving and are going to sue us for all the rent that they paid to live there and any renovations they made there. We never asked them to do these renovations. They took it upon themselves to do so, some of which we were never privy to beforehand. My question to you is, do they have a case? Will we have to pay them back for 2 yrs of rent and renovations?

    • Rob Berger says:

      Mark, it’s impossible to give you any legal advice. You’ll need to consult a lawyer. That said, I find it hard to believe based on what you’ve said that they have a basis to get their rent back. Good luck!

  27. Shaun says:

    Re: Rent Credit. Is there anyway to avoid paying income tax on this portion of the rental income since it “may” be converted to principal payments?

    For example, can it be escrowed?

  28. Raine says:

    Can rent-to-own only be 1-3 year agreements? Is it not possible to rent-to-own until an agreed upon price is paid?

    • Rob Berger says:

      Raine, I’ve never had a rent-to-own agreement with a term longer than 3 years, but I know of no reason why you couldn’t. As a landlord, I like longer agreements because it minimizes vacancies. So if you can get a longer agreement, I would. But you may want to consider putting automatic rent adjustments in the lease agreement.

  29. Verna says:

    How do you know what rental amount to pay and what should be extra to go towards purchase? (Asking price is $119,500- Zillow is $112,000. Who pay taxes, rent, HOA dues? Should there be an amount paid to keep purchased price firm? Would this go towards purchase? Should you pay the asking price or the Zillow amount? Do you need to use a real estate lawyer?This is an excellent website. Very helpful?

    • Rob Berger says:

      Verna, those are all great questions. As a landlord, we always charged an upfront fee of 1% of the sales price. The fee was nonrefundable, but went toward the purchase price if the tenant exercised the option. The sales price was always fixed. And about 15% of the rent went toward the purchase price if and when the tenant decided to purchase. However, our lease option terms were always tenant-friendly, in my opinion. I’ve seen agreements that favored the landlord (e.g., no stated purchase price, much higher upfront fee, etc.). A lot comes down to what you can negotiated. In terms of the value of the home, I never rely on Zillow. In my experience it is highly inaccurate.

      • And don’t look to attorneys for counsel on the subject of lease option. I have been through dozens of attorneys and I have come to the conclusion that they just don’t get it. They have been trained to represent a client on one side, or the other, of an issue. They cannot play the middle man; they seemingly cannot represent a seller and a tenant buyer in a dual capacity. Further, they see liability around every corner. Sure there are risks associated with lease options, but the benefits can far outweigh the risks. . I’ve spent thousands (as a KW agent) on education, contract review and continue to train on this niche business model (aka rent-to-own). It is a model that in not for everyone but when it is, it can be a real win/win for all involved. I have found LegalShield to be a great resource for legal counsel on a variety of issues from the trivial to the traumatic (including Lease Options).

  30. Vernon F says:

    I was in a 1 year rent to own lease with an optional second year that ended was back in December of 2011, it is now October 2012 and no new lease was ever signed. Am I now just considered month to month or what ?

  31. Vickie Pearce says:

    Hi. I’m a seller considering to offer my home as a Lease Purchase. The offer is to good friends and I want to make sure all of the parties are protected as much as possible and comfortable with the transaction. We plan to work with professionals and get everything in writing.

    For their peace of mind……. I was interested in your answer to Tiffany’s question:
    What happens in a situation if the SELLER changes his mind?

  32. lorie says:

    Hi, I have a family very interested in doing a lease purchase on my property. Most of the terms have been discussed and are fair to both parties. My questions are:

    Does the option fee have to be held in escrow or can it be used by me,the seller,at any time, since it is non refundable? I know it counts towards down payment.

    Is the rental premium placed into escrow account? I assume that the bank financing loan would want to see that money put aside.

    Buyer is offering to pay for maintenance up to $500 and all general upkeep. So what if frig needs to be replaced or the roof needs to be replaced? Who is responsible,, and can the accumulating rent premium be used for a large issue?

    Seems like good idea to get termite inspection. If it is clear should buyer or seller continue with a monthly warranty? Also, if home is generally in good working order, disclosure discussed, and home is being sold “as is”, is it fair to expect all maintenance is taken on by buyer?

    Are there any reasons a buyer under contract can back out of purchase and receive rent premium refunded?

    Thanks for any input you can give. I am currently in bankruptcy with 100percent payback and am losing over $200,000 in equity as my home has not sold for over 2 years. I am so happy to find people who love my home as much as myself and want the terms to be a win win for both of us.

    Lorie

    • Rob Berger says:

      Lorie, great questions. Here’s my take:

      1. Option Fee: Like you, our option fees are nonrefundable, so we don’t put them in escrow. They belong to us upon payment.

      2. Rental Premium: We don’t put that in escrow either. We make the rent premium non-refundable, so we never have to pay it back.

      3. Maintenance: Having the tenant pay for maintenance is a great plan (so long as you have confidence they’ll keep the place up). I’ve never views something like a refrigerator as maintenance, but it could be if you write the contract that way. I roof is a closer call, although you’d eat up the $500 fast. One way to look at it is that capital improvements are not maintenance. But again, the key is to be clear in your agreement.

      Finally, if you have a realtor, they should be able to help you with these questions as well.

      Best of luck.

      • Gary says:

        I thought you said in your article you didn’t believe in rent premiums, that you heard “horror stories” of people paying higher rent? You said “rent should be whatever reasonable market rent the home justifies. The rent should not be higher because of the lease option component of the deal”. Which is it? You said “rent is rent”. Well, premium means just that, a premium above the market rent to be applied toward the purchase price. PLEASE, any renters reading this, PLEASE take it with a grain of salt. Do some real research.

        • Rob Berger says:

          First off Garry, let’s take a deep breath. The good news here is that the fate of the universe doesn’t hinge on whether you and I agree on how to approach a lease-option. What I can’t figure out from your comments is whether you are pro-landlord or pro-tenant. That being said, in my experience, there is a range of rents that are reasonable. It’s not as if there is one reasonable rent, and a penny more or less makes it unreasonable. Given the types of homes we rent, the reasonable range is usually within $100, say $1,100 to $1,200. What we typically do is charge the high end of this range for a one-year term, and the low end range for a 2 or 3-year term. Why? We’ve learned that the biggest expense is vacancy and turnover. And the rent we charge doesn’t change for a lease-option. Now, you may agree or disagree with that approach, but I think it is fair for both parties, and our tenants agree.

  33. Gary says:

    Are you serious? NO ONE in their right mind would sell their home under the terms you describe. I have NEVER seen an article on a RTO anywhere on the internet so misinformed as yours. Just ask yourself, would YOU agree to lock in a price – negotiated at todays market – to sell your home 3 years in the future for a measly 1% of the purchase price as your only incentive?!?!? $2,000 to sell your $200k home with no further financial penalty to the buyer if he changes his mind? Locking in a price based on todays market to an unqualified buyer and a fixed rent amount would be insane for the seller. No owner with half a brain would agree to this. An option fee of at LEAST 3% (non-refundable) and a rent premium of at least 20% would be the MINIMUM any savvy seller would/should accept. Why is paying a rent premium a “horror story”? ALL the rent premiums and option fee are applied to the purchase price when the buyer exercises his option, a “forced savings” for the buyer if you will. Gives the buyer incentive to complete the deal and the seller incentive to lock in a fixed price/rent. If you have a house you would sell to me under the terms you describe, sign me up. What have I got to lose? I could negotiate a price based on todays market, live in your house at market rents with none of the ownership responsibilities, watch my equity grow with my only risk being 1% of the value we agreed on. I wouldn’t even exercise the option. I would just sell the option and collect the equity you put up all the risk for and traded away for chump change. This article is ridiculous. Please remove it, or at least correct it as you are misinforming buyers what they should reasonably expect in a RTO.

  34. Gary says:

    OH MY GOD! I’m rolling on the floor wetting myself! I wrote my other comments when I got as far as your stupid “1% rule”. I went back to amuse myself a little more when I saw you ACTUALLY give back 15% rent credit to the renter toward the purchase price you negotiated at market value from 3 years previous! BAhahahahahah! Please, stop, you’re killing me!! There went ANY “profit” you got from the 1% option fee! (wiping tears from my eyes) You actually do THIS?!? OMG, and you are an attorney?!? Why on earth would you do that? You are gaining NOTHING and trading away EVERYTHING! Only in a plunging real estate market would this gain the seller anything, and it is unlikely any buyer would pay a option fee unless the market is stable or climbing. THINK about it for a second, please! Everything is in the buyers favor and I can’t see one single incentive to the seller. I’m sure you as the moderator won’t post my comments, but I see at least a few other people with a bit of common sense pointed out your ignorance in this matter. PLEASE, PLEASE, remove this article!

    • Rob Berger says:

      Gary, you make me laugh. Been doing this for years, and one thing amazes me deal after deal. Renters pay the rent to own option fee and then never buy. I’ll never understand it. Anyway, I think the arrangement is very fair, and when you factor in savings of 6-8% in fees we don’t have to pay when we sell, the profit is quite good. However, you always have to keep your market in mind. I buy real estate in Ohio. This is not a market where prices will jump 30% in three years. Won’t happen. Anyway, thanks for your entertaining comment.

  35. Gary says:

    A 15% rent rebate off of market rents, a price negotiated at todays prices and locked for 3 years, all the equity gained during that time in my pocket, none of the risk or burden of a home owner, the right to sell my option and make a huge profit off your house, and all for 1% of the price we agreed to, which I get back if I buy the house. Incredible. Incredibly stupid.

  36. Gary says:

    And, oh yeah, my credit is shot and a bank wouldn’t touch me with a 10 foot pole, but I’m a “virtual” homeowner anyway with ALL the benefits, NONE of the drawbacks, and putting up almost no money of my own, thanx to you! Bwawhahahahahah!!!

  37. Gary says:

    Kudos Rob for posting my comments when you didn’t have to….but I’m sorry, you’re wrong. Even in Ohio, you’re wrong, or at least not fully explaining how this formula works for you, the seller. It ONLY works for you because Ohio renters don’t have the sophistication to exercise their option, certainly something the average seller would NOT want to depend on. And the problem is your article is read everywhere, not just Ohio. I agree, renters frequently don’t exercise their option but for your formula to work for the seller the renter would have to NEVER exercise their option. Obviously, many renter DO finally buy. Based on your formula, if you did 10 options on $200k homes as you describe, all you would have to have is one of those homes gain 10% in value (certainly plausible, even in Ohio), and that particular renter exercise his option on that one house and you just lost every cent of “gain”. The hassle and headache of 10 option agreements, all gone with one home gaining 10%? No way! A more realistic (and normal) option fee of 3% in the same scenario and you still net $40k even if every renter exercises their option. And who says you have to do an option to avoid the 6-8% in realtor commissions? I do it all the time in a straight sale. Since I place most realtors in the food chain somewhere between a pimp and a used car salesman, I avoid them like the plague unless I absolutely have no choice. And the rent rebate? Absolutely no rhyme or reason to that one. Your formula is a losing proposition to the seller EVEN WITHOUT that gift to the buyer. That is just icing on the cake for the renter. You are actually LOSING money on EVERY OPTION YOU DO!. Take a look, using a $200k home: Option fee $2000, check. Rent paid over 3 years (let’s assume $800/mo) $28,000, check. Rent rebate, $4,320, check. Net to seller, NEGATIVE $2,320, uhhhh…….check. And for what? To sell a house – even if the market is stagnant – for the same price you could have got 3 years prior, except you would have collected the full market rent during that same time period? DO THE MATH Rob! You’re formula just doesn’t make sense, EVEN IN OHIO!!! It reminds me of a joke of the two rednecks who buy watermelons for $1 each in the country, drive to the city and sell them for $1 each. After a few months of no profits, they conclude they need a bigger truck. Come on man. Suck it up and admit this formula only works if the buyers are morons. And PLEASE, make some corrections to your article or at least reference your formula can only be expected to be found in Ohio on homes owned by YOU. Or at a MINIMUM, explain that the ONLY reason a seller would ever make money this way is if the buyer DOESN”T exercise his option (apparently the way you do). I guess if you sold anything (new car?) for any amount of money ($100?) and the person never comes to collect their purchase, you would in fact make money.

    • Rob Berger says:

      Gary, I couldn’t disagree more. As with rent (see my comment below), a reasonable price for a home at the start of a lease-option falls within a range. There is no one reasonable price. For a 3-year lease-option, we tend to set the price at the high end of the range, and agree to sell the house at that price during the term of the lease-option. A 3% lease-option fee is both unreasonable, in my opinion, and unrealistic for the types of homes we own. If that works for you, great. But it doesn’t work for us.

      And I don’t follow your example. First, we charge rent of about 1% of the value of the home. That’s the market in Ohio. Second, I don’t follow how you conclude a negative amount to the seller. Take a $130,000 to $140,000 home. We would set the lease-option at the high end and get a non-refundable lease-option of $1,400. We charge rent of let’s say $1,300, just a tad below 1% and offer let’s say a $200 per month credit should they buy the home. Assuming they buy at the end of 3 years, they have a credit of $8,600 ($1,400 + ($200 x 36 months). So they pay us $131,400.

      Now what’s the value of the home. At the start of the lease-option, it was worth $130,000 to $140,000. Three years later in Ohio it’s probably worth $130,000 to $140,000. In a “hot” market, it might be worth $135,000 to $145,000. But of course, we’ll be paying 6% in realtor fees plus about 2% in closing costs (standard where I invest).

      For those renters reading these comments, I’d suggest never agreeing to a lease-option that doesn’t have a fixed price that is reasonable. There’s no value in buying an “option” to purchase the home in the future at some as yet agreed to price.

  38. Jamie says:

    Hi Rob,

    Thanks for this article. It has helped me as a potential tenant who wants to propose a lease option to an investment company that is renting out a number of homes in my area. They have one particular property for rent only and we love it. It has been sitting vacant and they have continued to market it as a rental. They have already reduced the $1750 monthly rent to $1650 after two weeks on the market. And it is now still available but no further reductions. It has now been almost 2 months on the market.

    We have called the company and was told by the receptionist that they hold onto these investment properties for 25 years before considering selling because they got such a great deal on the rate and purchase price.

    My question is how do I convince an investment company that it makes more sense to let us lease option on this property instead of only renting it? I ask this because it’s not just a homeowner but a company that rents out the property as their sole business. This particular company has purchased nearly 40 homes in my area that were short sales, mine included but is still pending (hence why we need to either rent or lease option our next home).

    Although we love the house, it does not make sense to only rent it long term. For one, the rent amount they want we could buy a home for less once we got our credit improved, and two, typically under rental agreements rental rates increase so who in their right mind would want to rent long term knowing they will continue to pay a ridiculous rental amount. And I don’t understand why the investor would think it makes sense to hold onto the property for 25 years before selling regardless of what great rate they got.

    The house is valued about $173,841 by Zillow and $178,836 by eppraisal.com and $202,449 – $237,658* by homegain (which I think is more accurate if it wasn’t for the current market). The home sold in Dec 2012 for $168k to this investment company. The current rental rate at $1650/mo even for this house I think is high given what surrounding homes have advertised for rent.

    This company’s portfolio just in my area has nearly 40 homes, so I figured why wouldn’t they let just one property go into a lease option? Unless I am missing something from a landlord/investment company’s perspective in why it makes sense to hold on to the investment long term.

    Furthermore, do we have much going for us to negotiate on the house purchase based on the current value and rental values of the area? This house really could sell in a good (normal) market for $220k+. That’s probably why they want to hold onto it.

    Sorry this is long-winded but you have some great info. Any suggestions are very much appreciated! Btw, why do so many lease options never make it to an actual sale, especially if you negotiate in the beginning?

    Thanks!
    J

Speak Your Mind

*