How Do Rent-to-Own Home Contracts Work?

How Do Rent-to-Own Home Contracts Work?
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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:

  1. Deposit the money into an escrow account and refund it on the closing date
  2. 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

Tip

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.

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