A Rent to Own Guide

Lease Option Contract

You’ve found the perfect Rent-to-Own home, spoken with a loan officer for advice, and you’re ready to get the process started. What now?

The lease option contract is one of the most important components in the Rent-to-Own process, as it dictates the terms of the agreement and sets them firm in a legal sense. The lease option contract is how buyers and sellers protect themselves from scams, and how each can get the best terms out of the agreement.

Much of the lease option contract resembles a renter’s lease contract, with the addition of the option to purchase.

Lease Option Contract = Renter’s Lease Agreement + Option to Purchase

Knowing what to look for and how to read into your lease-option is crucial for understanding the terms you are signing up for. After surveying a variety of lease option contracts, we have assembled this analysis of key clauses to keep an eye out for:

1. Purchase option.

The most noteworthy of clauses is the section dedicated to the purchase itself. This clause should state everything that is being promised as part of the purchasing process. Some of the common items you’ll find in this section are:

  • The option fee (usually at least 3% of the property price)
  • The fixed property value
  • The rent credit or how much of the monthly rent will be credited to the purchase price
  • This section should also include what happens if the seller chooses not to exercise the purchase, if this is not listed in a separate section. An excellent example of this is featured as the first clause here.
  • Option to Purchase Expiration/Closing Date

2. Lease term.

Much like a renter’s lease, the duration of the lease term is listed on the lease, as well as what happens at the end of the lease. For the lease-option contract, this clause can also include proceedings for what happens if the lease ends and the tenant/buyer is unable to execute the sale and whether the rental portion of lease will be extended, or is the agreement terminated and the deposit lost. This section also indicates what happens if the tenant/buyer is unable to finish the lease term.

3. Rent and rent terms.

Once again, this section will resemble a renter’s lease with additional important terms such as:

  • Monthly rent due date
  • Amount of monthly rent
  • Late fees that may be levied

Tenant/buyers should be cautious of rent terms that will invalidate the sale agreement for late rent payments. This will often be included in the section on default, discussed in #7.

4. Personal property.

Knowing what appliances and other personal property are included as part of the sale is important for an effortless transition at the end of the lease term. Putting this information down in writing will prevent headaches for both seller and tenant/buyer in the long run.

5. Maintenance, repairs, alterations.

A great selling factor for both tenant/buyer and seller, the ability to do basic maintenance and alterations on the property should be clearly addressed in the lease. What type of repairs the landlord is responsible for during the lease term will prevent a legal battle over who is responsible for fixing a roof or furnace (both expensive fixes if needing replacement). Plus, establishing the types of modifications that can be made to a home, as well as the process of getting landlord approval, sets a legal precedent in stone to prevent confusion. If the contract states the buyer is responsible for repairs, then take note of two things:

  • Have an inspection done and
  • Check the air conditioning, central heating, home warranty, roof warranty and similar items.

6. Deposit funds.

The deposit when leasing to own is called the Option Fee. This is usually 3% of the property value. Any deposits put towards the final purchase of the home should be accounted for in the lease. It should also include language describing if the deposit is non-refundable (in most cases, it is).

7. Default.

Your lease will likely include a clause describing the terms for default on payment (i.e. how many days of being late on payment will you get defaulted) as well as any termination of rights in the agreement that results.

8. Examination of title.

Terms protecting the right of the tenant/buyer to examine the title report and report valid objections should be included as part of the final sale. The tenant/buyer should have a specified time frame to examine the lease, as well as a time frame during which the seller must attempt to get the exceptions removed. This clause will give the option for the tenant/buyer to terminate the sale if the exceptions cannot be removed, as they see fit.

9. Utilities and taxes.

The lease agreement should list out who pays for both utilities and any applicable taxes. This information may be listed under a heading titled “Covenants.” In most RTO scenarios, utilities will be covered by the tenant/buyer, the property taxes by the seller. Take special note if you are the tenant/buyer regarding taxes, as they can become an unexpected expense if you are tasked with paying them.

10. Closing and closing costs.

A standard clause regarding closing costs, which should always be taken into consideration as part of the final purchase. This can include costs for:

  • Inspection
  • Surveying
  • Legal counsel
  • Title costs
  • Brokerage commission
  • Mortgage application fees
  • Points
  • Appraisal fees
  • Warranties
  • Prorated loan interest
  • Prorated property taxes
  • Homeowner fees

These costs will be paid by the tenant/buyer if they exercise the purchase option. Closing costs on a home can be considerable–between $3,000 and $5,000 on a $150,000 home–and should be factored into budgeting for the final sale. Some real estate agents recommend allotting the accumulated rent credit to the closing costs of the home.

11. Assignable/Non-assignable.

Your lease should spell out whether or not you are allowed to transfer your agreement to another party. Essentially, if you want to sell your lease-option agreement to another person, your contract should spell out your rights or restrictions when doing so. This is similar to a subletting clause. Nearly all contracts will require landlord consent as part of transferring an agreement.

12. Finance clause.

This clause states that the tenant/buyer is solely responsible for getting financing, a process that both parties acknowledge is unpredictable. This states in writing the risk and responsibility involved in being a RTO buyer, absolving the seller of responsibility if the tenant/buyer is unable to buy the home and the agreement ends.

Overall, one thing you have to remember when drafting a Lease Purchase Agreement with the seller is always consult with your local real estate attorney and have them write it. At the end of the day, the LPA has to be both friendly to both seller and buyer. A good agreement has to give the seller leeway to remedy if the buyer defaults. At the same time, buyers need to be wary of trick clauses that invalidate the agreement for small things, such as a day-late payment.

In addition to your lease agreement, there are several documents associated with purchasing a home that you should familiarize yourself with. Many Rent to Own realtors and experts recommend including documents made up specifically to spell out all the terms of your Rent to Own agreement (check out our list of other documents you may need when Renting-To-Own for your reference). And of course, if you have any questions or concerns whatsoever involving your lease-option contract you should never hesitate to consult your real estate lawyer.

Want a sample? Download a Lease Option Agreement here.