Don Tepper, Real Estate Pro in Fairfax, VA
Overall, some very good advice here on the pros and cons of rent to own/lease-options. Let me just throw in a few additional comments:
Several said things like: You will need "to have a large down payment." First, it's not a down payment. It's an option fee. Second, no it doesn't have to be large. From the seller's perspective, the larger the better. From the tenant-buyer's perspective, the smaller the better. It obviously can vary from place to place, but nowadays it's unusual in many areas for a seller to be able to get more than 2%-3% of the purchase price as an option fee. So, on a $400,000 house, many option fees would be in the range of $8,000-$10,000, and sometimes less. I've done lease-options without putting up any money. (For the legal eagles reading this and worried about the contract being legal, the "consideration" was the revenue from the one-year lease I signed.) The sellers were perfectly happy with that.
One answer stated: "Interest rates are normally higher than a mortgage company would be." That's incorrect. There are no interest rates. The tenant-buyer is paying rent. Typically, the rent is slightly above the so-called "fair market rent" for the area. And typically, a portion of that rent is credited toward the purchase price if the tenant-buyer purchases. So, in our $400,000 house example above, around Virginia that house might rent for $1,500 a month. An owner might charge $1,700 a month rent, and credit $400 a month toward the purchase if the tenant-buyer ended up buying. But there's no "interest rate" at all, and the payment amount is pretty much in line with comparable rentals, not with what one would pay with a mortgage.
Ben in particular gave some very good suggestions. However, one is largely impractical and could cause some problems: "If possible, have the seller agree to add your name to title -- Not all sellers will agree to this, but in this market more and more are. By adding your name to title along with the seller, you are assured that the seller won't sell the home from under you, and after 12 months ALL lenders will consider your interest in the home vested and allow you to refinance the home into your name instead of purchasing it. " First, while lease-option sellers may be
motivated, few are motivated enough to add a tenant's name to the title. Might be good for the tenant, but opens a big can of worms for the seller. For instance, if the tenant-buyer doesn't exercise the option, how do you persuade the tenant-buyer to remove his name from the title? Yes, it can be done, but that's a huge, powerful club the tenant-buyer would have. It also opens a huge can of worms from the perspective of the due-on-sale clause. It can be argued that even a carefully constructed lease-option can trigger a due-on-sale clause. Putting a tenant-buyer's name on the title certainly is a conveyance of equitable interest. Bad, bad, bad idea. On the other hand, Ben's point was excellent that the tenant-buyer wants to make sure that the property isn't sold out from under him, and that the owner isn't skimming the rent while letting the property go into foreclosure. So what you do (as a tenant-buyer) is have the owner sign an "Authorization to Release Information" that is then sent to all the lenders on the property. This gives the tenant-buyer the authorization to call the lender, just as the owner can, to determine mortgage balance, last payment, etc. Further, the owner and tenant-buyer sign a "Memorandum of Agreement" in a form (and notarized) so that it can be filed with the city or county land records office. This document "clouds the title" without revealing the details of the agreement. Then, if the owner tries to sell and a title search is performed on the property, the "Memorandum of Agreement" alerts the world that another party has an interest in the property that must be satisifed before title can be transferred.
And, of course, use a lawyer. However, recognize that not all lawyers are the same. And not all are well-versed in lease-options. When I was developing my lease-option paperwork (as an investor who does lease-options), I had one lawyer tell me that the idea was fine in theory, but didn't work in practice. I had another lawyer tell me he didn't like lease-options because they're unilateral agreements. That is, they're one-way; they give the tenant-buyer the OPTION of purchasing, but if that option is exercised, the owner is REQUIRED to sell the property. And Mr. Lawyer just didn't like the concept of unilateral agreements. So I found another lawyer who didn't have the same hang-up.