Lease Purchase Agreement: Benefits for Buyers and Owners

Amy Fontinelle is a freelance writer, researcher and editor who brings a journalistic approach to personal finance content. Since 2004, she has worked with lenders, real estate agents, consultants, financial advisors, family offices, wealth managers.

Amy Fontinelle is a freelance writer, researcher and editor who brings a journalistic approach to personal finance content. Since 2004, she has worked with lenders, real estate agents, consultants, financial advisors, family offices, wealth managers.

Amy Fontinelle is a freelance writer, researcher and editor who brings a journalistic approach to personal finance content. Since 2004, she has worked with lenders, real estate agents, consultants, financial advisors, family offices, wealth managers.

Amy Fontinelle is a freelance writer, researcher and editor who brings a journalistic approach to personal finance content. Since 2004, she has worked with lenders, real estate agents, consultants, financial advisors, family offices, wealth managers.

Chris Jennings is a writer and editor with more than seven years of experience in the personal finance and mortgage space. He enjoys simplifying complex mortgage topics for first-time homebuyers and homeowners alike. His work has been featured in a n.

Chris Jennings is a writer and editor with more than seven years of experience in the personal finance and mortgage space. He enjoys simplifying complex mortgage topics for first-time homebuyers and homeowners alike. His work has been featured in a n.

Chris Jennings is a writer and editor with more than seven years of experience in the personal finance and mortgage space. He enjoys simplifying complex mortgage topics for first-time homebuyers and homeowners alike. His work has been featured in a n.

Chris Jennings is a writer and editor with more than seven years of experience in the personal finance and mortgage space. He enjoys simplifying complex mortgage topics for first-time homebuyers and homeowners alike. His work has been featured in a n.

| Loans & Mortgages Editor

Updated: Feb 16, 2023, 11:00am

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If you own a home that you’re having trouble selling, or if you want to buy a home but you’re not financially qualified, a lease purchase agreement could be appealing. Here’s how they work, along with what you should consider as a potential buyer or seller under this type of contract.

What Is a Lease Purchase Agreement?

A lease purchase agreement—also known as a rent-to-own or lease-to-own agreement—lets someone rent a property for a specified period of time with the promise to purchase it at the end of the lease term. The owner is contractually obligated to sell the property to the renter when the end of the term hits. Likewise, it also obligates the renter to buy the property from the owner.

Lease purchase agreements are considered a type of alternative financing (like land contracts). There’s not a lot of data about how often these arrangements succeed, so both parties should approach them with caution.

We’ll use the terms renter and buyer interchangeably in this article and do the same for the terms owner and seller.

How to Structure a Lease Purchase Agreement

Property sellers and buyers can structure a lease purchase agreement however they want. As long as both parties find the arrangement acceptable, they’re free to set their own terms for both the rental period and the eventual sale.

However, certain terms may have to fall within guidelines established by local, state or federal laws, such as the Fair Housing Act and landlord-tenant laws.

Contract of Sale

The whole point of a lease purchase agreement is for the owner to sell the property and the renter to buy it. So, the contract needs to include sale terms, such as:

• Sale date (or purchase date): The day, month and year when the renter will give the seller the required sum to buy the property and the seller will file paperwork with the local government to record the ownership change.
• Sale price (or purchase price): The amount the renter will pay to purchase the seller’s property. This might be the property’s current market value plus an inflation, appreciation or depreciation factor.
• Option fee (and due date): The sum the renter will pay the owner (and when) for the exclusive right to buy the property on the sale date. This is typically not refundable.
• Option agreement: Whether the seller will put the renter’s option fee toward the purchase price or not.
• Right to sell the option: Whether the renter can sell the purchase option to another party (for example, if the renter needs to move out of state or realizes it won’t be financially feasible to buy the home).
• Owner default: The consequences if the owner decides not to sell the property.
• Buyer default: The consequences if the renter decides not to buy the property.

Both the buyer and seller may want to review each other’s credit reports for red flags as well. If the buyer’s credit is poor, they may not qualify for a mortgage by the purchase date. If the seller’s credit is problematic, their home could be at risk of foreclosure.

The contract should also outline who will pay certain closing costs. It may be wise for the buyer to perform a title search before signing the contract so that they can confirm—at least as of the lease start date—no one else has a claim against the property. Sellers must also provide buyers with certain disclosures about the property’s condition and history, such as lead-based paint disclosures for most homes built before 1978.

Similarly, it may be wise to pay for a professional home inspection and appraisal up front to make sure the property is worth the purchase price.

Lease Period

The lease period works much like a traditional lease, but with a few key differences. The contract will need to define the terms of the lease period leading up to the sale, such as the beginning and ending dates of the lease, monthly rent amount, security deposit, rent increases and penalties for late payments or breaching the agreement.

In addition, the contract should also go over the following:

• How much rent is allocated to the purchase price: What portion of the monthly rent payment, if any, will the owner consider to be part of the renter’s down payment toward owning the property.
• Escrow: Stipulating the use of an escrow service to protect the renter (and how the renter and owner will share the cost of this service). The escrow company will collect and hold the renter’s security deposit, option payment and portion of the rent allocable toward the down payment until the renter buys the home or defaults on the contract.
• Right to sublet: Whether the renter can sublease all or part of the home to anyone else during the lease term.
• Modifications: What changes, if any, the renter can make to the property.
• Lease cancellation: How much the renter will owe the owner, in addition to forfeiting the option fee and any additional rent, if they break the lease.
• Insurance: The owner may need to carry landlord insurance to protect the property the renter intends to buy. Renters may need to carry renters insurance to protect personal possessions and provide liability coverage.
• Property taxes: The owner must remain current on property tax payments.
• Maintenance, repairs and utilities: Which maintenance, repairs or utilities, if any, the renter will be responsible for and which the owner will be responsible for.

Buyers and owners may wish to add additional terms to the contract defining things like pet rules, smoking rules and parking fees. Each party would be wise to hire a real estate attorney or real estate agent to represent them and help protect their interests in drawing up the contract.

Pros and Cons of a Lease Purchase Agreement for Buyers

The renter will have to accept certain risks in exchange for potential rewards when they enter a lease purchase agreement.

Pros of a Lease Purchase Agreement for Buyers

• Time to improve finances: The lease period gives the buyer time to save up for a down payment and increase their income so they’ll be in a stronger position to buy and own a home. It also gives them time to pay down debt and establish a record of making monthly payments on time.
• Opportunity to lock in a purchase price and property: It can be hard to save for a home when market prices are a moving target, and it can be hard to find the right property to buy. A lease purchase agreement gives the renter a chance to secure their preferred home and purchase price without having to pay the full price up front.
• Chance to test out the home and neighborhood: While losing the option fee and any rent payments would be costly, they might be an acceptable loss if the renter decides the property is unsuitable for their long-term needs.

Cons of a Lease Purchase Agreement for Buyers

• Loss of down payment and option fee: If the buyer can’t improve their finances enough to qualify for a mortgage by the sale date, they forfeit their option fee and additional rent payments (if any) to the seller. They may also have to move and secure a new lease, both of which could be costly.
• Seller could fail to pay landlord insurance, mortgage or property taxes: If they don’t maintain insurance, there might not be funds available to repair any property damage a policy would have covered. If the owner’s mortgage lender or the local tax authorities place a tax lien on the property, it could prevent the renter from being able to buy it. The renter might even get evicted during the lease term. Other life disruptions (divorce, disability, serious illness) could also cause the seller to lose the home.
• Seller could back out: If the home’s value increases significantly over the lease period, the seller might have a strong financial incentive to break the agreement, assuming the contract doesn’t provide a significant penalty for doing so.

Pros and Cons of a Lease Purchase Agreement for Sellers

The property owner will also have to accept certain risks in exchange for the potential reward of selling their home.

Pros of a Lease Purchase Agreement for Sellers

• Sell an unmarketable home: Most owners would rather sell their home immediately and not deal with a lease purchase agreement. If attempts at a regular sale have failed, a lease purchase agreement could be the solution.
• Earn money even if the sale falls through: The option fee and possibly excess rent—along with the regular rental income from the property—could be better than letting the property sit vacant.
• Get a more responsible tenant: Someone who intends to buy a property will likely take care of it as if it were their own.

Cons of a Lease Purchase Agreement for Sellers

• Lose money if the home’s value increases: Locking in a sale price at the outset could backfire if the local real estate market appreciates more than expected.
• Tenant could be a nightmare: Even a tenant who seemingly wants to buy the home may take poor care of the property or fail to pay rent. The owner could have to evict them, which can be an expensive, lengthy and difficult process.
• Buyer could back out: If the home’s value decreases significantly from the lease purchase agreement price, the buyer might have a strong financial incentive to break the agreement. There’s also no guarantee that the buyer will be able to qualify for a mortgage when it’s time to buy the home.

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