Seems like a simple concept. Rent a property for a while and at the same time have the rent pay for part of the mortgage payment. At 30,000 feet this seems like a "win/win" for both the Landlord and the Tenant, right? Well, the answer to that question deserves a second look, and since we seem to answer it almost every week, it has become worthy of it's own blog post. The idea of a "Rent to Own" or Lease Purchase Contract is enticing. It can easily roll of your tongue and the name can easily turn into the definition. For a Landlord, you have a buyer and in this market, who doesn't want more of those. For the tenant, you have the security of knowing that not all of your rent is going to waste and you are building equity each month. However, as easy, and as tempting as it may be to simplify, its just not.
In fact, this became so over-simplified that by 1988 the State of Virginia legislated Chapter 59.1, Section 207 of the Virginia Code (Virginia Lease-Purchase Agreement Act of 1988). This Act details what must, and must not be included in a Lease Purchase Contract in order for it to be valid in the State of Virginia. Your first hurdle, whether you are a Tenant or a Landlord, is to make sure you have a contract that is both legal and enforceable.
The way a Lease Purchase contract essentially works is a seller (lessor) of a property will offer a lessee (buyer) a home lease. After a specified time period, the lessee may choose to purchase the property for an agreed-upon price. The buyer is charged an option that comes to 1 to 5 percent of the property's purchase price, for the option to buy at that agreed upon price, which is due when the contract is signed. If the buyer chooses not to purchase the home after a set period of years, they will lose the option fee. Additionally, a Landlord will also collect an extra amount of rent each month, to be held in escrow, to contribute to the down payment of the home. The 2 parties must agree on duration, cash price, option fee, and other things that are common in a lease such as maintenance and reporting of rental receipts. Furthermore, the buyer must still come up with financing to purchase the property, which was probably the reason why the home wasn't initially purchased in the conventional method. In addition to getting the terms of the contract legally binding and followed each month, you must also be aware of the trend of the market so that you price the property correctly. While identifying trends is relatively simple, knowing exactly where the market will be in 1-5 years is impossible (even Warren Buffet gets it wrong) and it is difficult to determine what fair market value will be. In the end, either the Lessee or the Lessor will end up the loser of this guessing game. As you can see, this has the potential to get really messy.
There are currently governmental programs through Freddie Mac that offer low-moderate income families Lease Purchase contracts for certain properties, and there are companies who specialize in rent-to-own contracts of their own properties. However, in the normal Real Estate market their occurrence is very, very rare and requires careful and meticulous planning by both parties.
In summary, while the notion of "Rent-to-Own" may seem like the perfect option, please make sure you know exactly what you are getting into.
