A rent-to-own home contract, also known as a lease-option, incorporates a purchase option into a traditional rental or lease agreement. Although not all states have laws governing rent-to-own contracts, those that do generally provide for a rental period of about 1 to 5 years. After this time, the tenant can exercise the option to purchase the home from the owner according to the terms of the agreement.
How an RTO Works
An RTO gives a tenant the legal right to live in and eventually buy a rental home within a specified time in exchange for an option fee. Although a landlord can require the fee as a lump sum payment in addition to a security deposit, it more often is paid in the form of a higher-than-market rent in which a percentage is applied to the purchase. For example, the landlord might increase the rent payment from $800 to $900 and credit $100 toward the eventual purchase.
The landlord has two options for handling the option fee:
- Deposit the money into an escrow account
and refund it on the closing date
- Use the option fee to reduce the agreed upon purchase price of the home
According to Nolo, unless the contract terms state otherwise, a tenant who does not exercise the option within a specified period usually is not entitled to a refund of the option fee.
One Document, Two Objectives
An RTO agreement can consist of two separate documents, or incorporate everything into a single document. Regardless, the rental portion and the option to purchase portion are stated separately from each other.
The Rental Agreement
The rental portion of the agreement usually differs from a standard rental contract. For example, in addition to standard terms such as the length of the rental period, the amount of the security deposit and monthly rent payments, and a clause giving the homeowner the right to evict for nonpayment, the agreement may specify the tenant is responsible for making -- and paying for -- all necessary maintenance and repairs.
The Option Agreement
The option to purchase portion is the critical part of a rent-to-own agreement. According to Nolo, in addition to clauses required by state laws, if there are any, the agreement must specify
- The option fee and how it is to be paid
- The length of the option period, including a final date on which the tenant must either complete the purchase or allow it to become null and void
- The purchase price of the home, or an agreed upon method -- such as a professional appraisal -- for determining the purchase price in the future
Whether you use a standard rent-to-own contract template or draft one from scratch, Nolo recommends that both parties work with or consult a real estate attorney to draft or review an RTO. A tenant also should order a professional appraisal before signing the agreement. This is vital not only to make sure the purchase price is fair, but also to assess the extent of any needed repairs.