What Is A Lease/Purchase?

A lease-to-own house purchase (also "rent-to-own purchase" or "lease purchase") is a lease combined with an option to purchase the property within a specified period, usually 3 years or less, at an agreed-upon price. The borrower pays an option fee and a deposit, which is credited to the purchase price. The borrower pays rent, and an additional rent premium that is also credited to the purchase price. If the purchase option is not exercised, the buyer loses the deposit including the option fee and the rent premium.

Lease-purchase deals can be structured in such a way that all parties benefit. Lease-purchase plans have a solid economic rationale. A lease-purchase has 6 major provisions. The sale price of the house and the rent are market-determined, yet subject to negotiation just as in a straight purchase or rental transaction.

Buyers generally prefer a long option period because it provides more time to build equity,increase appreciation, and repair credit. A long period can boomerang on them, however, if they are never able to exercise the option, since they lose the rent premium they have been paying all the while plus their option fee. Sellers generally prefer a short option period, but if it is too short, the house won’t be sold.

The option fee and rent premium are viewed differently by buyers and sellers. To the buyer, they are part of the equity in the house they will soon own. Fully anticipating that they will exercise the option, the only cost is the interest they would otherwise have earned. To sellers, however, these payments are the best guarantee that their houses will sell; if they don’t sell, the payments are retained as income. That the benefit to the seller generally exceeds the cost to the buyer makes the lease-to-own deal a possible win-win.

A lease-purchase also may give the renter/buyer the right to assign the option to buy. This will usually have considerable value to the buyer, because it means that the option can be sold in the event that it has value but the buyer is not able to exercise it. It is a cost to the seller for the same reason.

A possible alternative to a lease/purchase deal for consumers with poor credit and/or no cash is a sub-prime loan. The high-cost sub-prime market, which actively solicited clients and victimized many, was pretty much gone by 2008 but sub-prime loans continue to be available at reasonable prices from community groups or state and local finance agencies. Borrowers have to search out these sources, but if they can qualify for a loan from one, it is probably a better route than a lease/purchase.

The lease-purchase offers homeownership opportunities to consumers who can't qualify for a loan from any source, but who are prepared to bet on themselves. The bet is that before the option period expires, they will qualify for the mortgage they need to exercise the purchase option. During the option period, they have the opportunity to rebuild their credit and accumulate equity while living in the house.

Even though it is costly, the right not to exercise the option is of value to buyers. If there is something seriously wrong with the house, neighborhood, or neighbors, the money left behind on a lease-purchase is much smaller than the cost of an outright purchase followed by a quick sale.