'Lease-to-Own Purchase' is explained in detail and with examples in the Investments edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.
A Lease-to-Own Purchase is a combination of a lease on a house with a purchase option on the home. This option is valid for a specific amount of time, typically for 3 years or less. The price for the purchase is agreed on in advance and is a part of the contract. These types of arrangements became far more common after the housing crisis and Great Recession. Many individuals who wanted to buy a house could no longer qualify for the stricter loan requirements. This also impacted sellers who could not obtain a selling price with which they were satisfied by any other means.
With a Lease-to-Own Purchase, the contract is typically designed and provided by the seller. The benefits of the arrangement can be set up to provide advantages to both buyer and seller parties. They might also be arranged so that the majority or even all of the benefits accrue to one side. This means that buyers should beware before entering such an agreement. It is wise for them to share the contract with a real estate attorney before they sign.
In a traditional Lease-to-Own Purchase contract, borrowers first pay an option fee that goes against the cost of buying the house. This generally amounts to from 1% to 5% of the home price. The renter will also pay a fair market value rent alongside a rent premium that also goes towards the price of buying the house. Everything is negotiable in these contracts, including option period, option fee, rent premium, rent, and the price of the house. Should the purchase option not be exercised by the renter, then he or she forfeits the rent premium and the option fee to the seller.
Buyers will naturally want a longer option period. This gives them a greater amount of time in which to repair their credit and save up money for a down payment. The downside to a longer option period in a Lease-to-Own Purchase comes into play if they can not exercise the option to buy. In this case, the renters forfeit both the option fee and the monthly rent premium which they have paid continuously. Sellers will want a shorter time period on the option. If they make it too short, they will be unable to sell the house to the renter.
It is possible for a Lease-to-Own Purchase to work out to be a win-win situation for both parties. The rent premium and option fee to the buyers represent equity they are paying into the house which they expect to buy. Such payments are compensation towards a guarantee for the seller that the house will sell. The seller will get to keep the additional payments as income if the buyer is unable to obtain the mortgage needed to purchase the property.
Some Lease-to-Own Purchase contracts will provide the renter with the ability to sell their option to another party. Such an option gives buyers additional confidence in the deal in the event that they are unable to personally exercise their buying option. This is a concession from sellers who would rather keep the house along with the fees they have collected. Some lease contracts will also have clauses that can cancel the buyer’s option. These are often set as penalties for late rent payments.
One advantage to leasing the house before buying it lies in buyer awareness. The renters have time to consider any significant problems with the house, neighbors, or the neighborhood before they commit. If these are substantial issues, the buyers are able to cut their losses and not go through with the buying option.