Landlord 101: How To Do A Lease To Own Contract

Have you ever had a tenant move out because they want to find somewhere they can buy or live for a long-term tenancy? Landlords in some areas will be asked if lease to own agreements are an option at their properties.

Even if you haven’t considered this setup before, rent-to-own homes can be a great option for landlords who are ready to change up their revenue streams. This lease agreement type can help you to sell off some properties while still making an income, and there are a number of other benefits as well.

The key, however, is to be sure that you know how to set up these agreements so they are safe, effective, and profitable.

Today’s rent-to-own guide for landlords will cover, from start to finish, what you should focus on while making this type of agreement.

A Table Of Contents For How To Set Up Rent To Own

What Does Renting-To-Own Mean?

What Does Renting-To-Own Mean?A rent-to-own contract is a rental agreement that includes either a purchase guarantee or purchase option. The arrangement allows the tenant to rent the property while also paying down on the house deposit monthly.

Additionally, the rent-to-own contract gives tenants the exclusive first purchase option at a specified, future date.

Essentially, the agreement acts as a lease agreement as well as a purchase agreement. The contract sets up the basic terms of the agreement so both parties are aware of how the purchase could happen.

Through a rent-to-own contract, renters who aren’t quite ready to buy can begin the process of owning their first home while landlords can also secure a potential sale while still renting the property.

The Basics Of Rent-To-Own Agreements

What are the basics of a rent-to-own agreement? These agreements are typically made up of two primary parts:

  1. Lease/Rent Agreement
  2. Purchase Option

These parts can be combined into one agreement or signed as separate agreements, but they must both be signed by all involved parties in order to make a rent-to-own contract. We’ll cover what should be included in more detail in the next section.

Lease/Rent Agreement

The rental agreement is going to be very similar to a standard rental agreement, and it should cover everything you would typically include in these contracts. This contract is focused on the terms of the tenancy, the responsibilities of each party, the lease period, and what rent will be paid.

Purchase Option

The option section of the agreement is the section that gives the tenant the right to buy the rental property at a specified time.

Typically, this is how a purchase option works:

  1. The tenant puts down an option fee – this gives them the right to purchase the property at a later date and is nonrefundable.
  2. The parties agree on a date when the property will be purchased by as well as a price.
  3. The tenant pays the normal rent each month as well as a rent credit, which is an additional payment that is put towards the house purchase each month.

Of course, the exact terms of the arrangement are going to vary on a case-by-case basis. The details should be clearly outlined in your rent to own agreement.

Landlord Benefits

There are many reasons why landlords are often willing to set up a rent-to-own situation; these are the most common:

  • Attract Potential Buyers
    Properties that haven’t brought in buyers on the market may bring in buyers who are hoping for a rent-to-own situation through this arrangement.
  • Earn Income
    If you want to sell the property in the future but aren’t in a rush to do so, a rent-to-own setup will bring in income while you are also preparing for sale.
  • Better Price
    You may be able to set the sales price higher through rent to own than you would be able to get at this time. Renters are often willing to pay for the option to buy.
  • Easier Upkeep
    While you are still responsible for your usual landlord responsibilities while in this arrangement, tenants who are planning to buy after their tenancy have a vested interest in helping to keep the property in the best condition.
  • Keep Option and Escrow
    If the tenant decides not to buy, you still get to keep the option fee and funds that had been set aside for the purchase.

Landlord Risks

If you’re considering using rent to own for a property, consider if the risks are something that you can mitigate:

  • Lack of Certainty
    In most rent-to-own arrangements, the buyers are not required to buy; they simply have the option. They may decide not to buy in the end, and you’ll have to start searching for a new buyer.
  • Paid Over Time
    Since the tenant will not be buying immediately, the influx of cash from the sale will come in over time. This gives you fewer funds to move around.
  • Locked-In Price
    The price is locked in when the arrangement is set. If house prices in the area rise rapidly, you could miss out on a great price. If house prices drop, the buyer may back out and you would have had better profits if you sold before.
  • Flaw Discovery
    Every house has flaws, but some may not be tested until a tenant is there long term. This could lead to more investment or disclosures in the future.

Step-By-Step Rent-To-Own Guide For Landlords

Now that you’re caught up on what a rent-to-own arrangement is and how it could affect your business, let’s break down how to put this setup into action for your properties.

Step 1: Determine Agreement Type

First, you and your tenant will need to agree on the type of rent-to-own situation you will set-up. It’s best if you have a contract set up that you can propose to the tenant.

As mentioned above, there are two main types of agreements, and they are used in different situations.

  • Lease agreement with a purchase option: tenant has the option, but not the obligation, to purchase the property at the end of the lease
  • Lease agreement with purchase agreement: tenant is contractually obligated to purchase the property

Most landlords and tenants use the purchase option, but you may prefer the purchase agreement if you need the certainty of a buyer.

Step 2: Set The Purchase Price

Next, you’ll need to determine the purchase price. The purchase price should always be set up front, but you could set multiple purchase options depending on when the purchase happens.

Once you’re familiar with the range of prices in the area, consider adding 5-10% to the price. Many landlords do this to help balance out rising home prices while also compensating you for the uncertainty.

Step 3: Collect The Option Fee

Step-By-Step Rent-To-Own Guide For LandlordsAn option fee is the upfront payment that a tenant makes to you in order to have a purchase option in place. Essentially, they are paying for the right to purchase the home at the end of their lease.

The option fee is negotiable, so you will want to work out what you believe is appropriate. This can range from 1% up to 7% of the purchase price. This one-time payment is nonrefundable, and it will be taken off the purchase price at the time of sale.

Step 4: Determine Rental Period

How long will the tenancy period be before the property sale occurs? Depending on when you would like to sell the property and when they will be financially able to make the purchase, this period typically lasts between one and three years.

Step 5: Determine Rent & Rent Credit Amounts

When your tenant pays rent each month, that amount will now account for more than just rent. The amount they pay monthly will be both their monthly rent for their ongoing tenancy and their rent credit.

Rent credit is an extra amount of money paid monthly that is considered to be a down payment on the eventual property purchase. This amount is usually set at 25% or 30% of the monthly rent, but the amount should be determined with your tenant.

Some landlords put this money into an escrow account until the sale occurs; others simply apply the value to the sale down the line.

Step 6: Normal Rental Conditions

As with any rental agreement, you’ll want to make sure the lease agreement clearly defines all roles, responsibilities, and other factors. In addition to the standard guidelines, the lease agreement should detail the terms that have been decided between both parties for the rent to own agreement.

One way that rent-to-own lease agreements often differ from standard agreements is that tenants will often be made responsible for the upkeep of the property since they will be its owners down the line. This, however, is dependent on the specific lease and area.

Step 7: Check In With The Tenant

As the tenant’s lease period comes to a close, check in with them about the purchase and what their plans are. If they still plan to make the purchase when the lease period ends, they will need to apply for a mortgage as you begin the sale process.

Rent-To-Own Eviction Laws

Is it still possible to evict a tenant if you have a rent-to-own agreement in place?

If the tenant breaks the terms of the lease in a serious or repeated way, it will be possible to evict them. Even though they are paying for the option to purchase the home, that does not give them the right to break the terms of the lease. Municipal court or a common pleas court will be able to judge the case.

If you encounter problems with the tenant, learn how to address those problems and move forward with eviction here.

FAQs: Rent To Own

Is Rent To Own Safe?

Generally yes, but it shouldn’t be treated as a guarantee.

Should A Tenant Consider Rent To Own?

If you have a tenant who isn’t sure that rent to own is right for them or not, they might ask you some questions about the arrangement. Generally speaking, this arrangement is best for tenants who:

  • Want to own a house but need time to build up funds or credit
  • Need time to qualify for a mortgage
  • Are able to pay an additional 15-30% each month towards the purchase
  • Want to lock in a good price

If your tenant fits these points, they may find the arrangement beneficial.

What Should Be Included In A Rent-To-Own Contract?

In addition to what is outlined above, you should also be sure that you research your local and state laws about what should be included in a rent-to-own contract. Some states require specific disclosure amendments and inspections before a lease-to-own contract is signed. If this applies, you will want to enact them.

Can A Landlord Break A Rent-To-Own Contract?

Unless the tenant breaks the lease agreement, there aren’t many situations in which you could easily end the rent-to-own contract. The option to give the tenant back what they have put down to end the agreement exists, but that would have to be negotiated between you and the tenant.

You should only agree to a rent-to-own situation if you are ready to commit to it.

Conclusion

The most important thing to remember while setting up a rent-to-own contract is that your contract should be detailed not only about the purchase option but also about the lease agreement. The contract sets up the future of the property, so take time to review things carefully so nothing is forgotten.

Now that you know how to set up a rent-to-own deal, you can set up a possible sale while still generating income. Remember that sometimes it is better to sell a property and move on. To hear more about how rent to own properties can diversify your business, check out our podcast episode on the topic.