Why Lease Or Rent To Purchase Agreement Is Not A Good Option

Only one lease to own has closed that I was involved in after 14 years in the biz. There has been so much volatility in the market values over the past several years it is a gamble to set a purchase price and expect that to stick when the closing happens if it ever does. I had a lady call me last summer who had entered into a lease to own as a FSBO for $210,000 three years prior and by the time the lessee was ready to close the value was down to $185,000. She called for free information advice from a realtor. I told her why most lease to own deals do not work out and sent her to her attorney to sort it all out. Sad that people get snookered into those deals.

I spoke with a potential buyer who thought he wanted a lease with option. First thing I asked him was had he already spoken with a lender. "NO". he was informed by his lender and a couple others not to do this. WHEW!  We have a couple agents in our area who handle these "LEASE WITH OPTIONS". The "DEPOSIT" is $5000.00 on most and not refundable. There is also a damage deposit and no pets allowed, the whole gammit. His brother entered into one of these lwo and wanted to extend for another 6 months. They were told it would be another $2500.00 as an extension fee and the rent would be increased another 100.00. If they still were not ready to purchase at the end of the lease with "a closing date". They would have to move. They were able to finally purchase the house but had to do a lot of financial juggling. That was a lot of money involved if they would have not been able to get financed. The potential buyer was able to purchase a nice house through FHA but not "LEASE WITH OPTION". 

At one time lease purchase was a buyers tool to leverage themselves into home ownership.  Now it is a sellers tool to allow the seller to get the price they think the property will be worth 12 or 24 months from now.  Those buyers that think they will correct their credit issues during the lease period seldom follow through.  We are past the period where the lease purchases could not close due to the price  being higher than the appraisal, or are we.

It is one of those arrangements that sounds better on paper than it actually is in the real world.  However if you are the property owner, it is a good way to get your tenants to maintain the property better and for them to put up big non-refundable deposits.

Wow George, that is an eye opener.  We do not like lease purchases either, but did not know about the FHA rule.

Interesting infomation. I didn't know that. Always treated the Down-payment as a completely separate issue.

George, nice post. I have also discovered this in the past by carefully reading the guidelines.

I always advice my people of this matter and they usually take it into consideration.

Seems to me the benefit is to the tenant. They can lock in the purchase price and not worry about competition from other buyers. AND... they can walk away at the end of the term if they change their minds, so the seller has no real guarantee that the house is sold.

If the seller receives extra dollars over and above prevailing rents, that's his compensation for keeping the home off the market during the lease period.

Of course, in today's climate, the buyer is also taking a risk. What if that seller decides to quit making the payments - so by the time the buyer is ready to proceed, the house no longer belongs to the original seller?

Risky business all the way around.  

Dear George,

I prefer first right of refusal for the tenant. They can be first in line to buy, if they can get the approval at the time. Otherwise, they need to move on to a less expensive propery or keep renting elsewhere. Purchase option agreements do not come to fruition often, because circumstances change and the tenant now needs a larger or smaller home, is moving elsewhere, cannot qualify or many other reasons, which means that the money assigned to the purchase defaults to the landlord.

George, not only is a Lease/Purchase, or a Rent-to-Own NOT a good idea, in Texas it is also something we as Realtors are NOT allowed to do.  We have no promulgated forms from the Texas Real Estate Commission for this, and must either refuse to do it, or refer these folks to an attorney.

By the way... I totally agree with this way of looking at it.  Send it to an attorney. 

Also... in Texas... attorneys do NOT take part in our transactions by writing up the contracts like they do in some other states.  It is all done by Realtors using State-Promulgated Forms.

George, When I teach pre-license and we come to this part of financing, we list all the things that can go wrong and the class comes to the assumption that it is not a very good idea for wither side.

I have never done a lease-purchase, because I never felt comfortable with them!  Now, thanks to you, I know why! Great post!

Thank you for this explanation because it helps me to understand this process better and give the right answer to potential buyers. I am and was never a friend of these purchase option and did not recommend it but many of my buyers ask me about it and now I have a good response for them.

One of the main reasons to not enter into this kind of arrangement is the honesty and integrity of the seller.  I have had a number of buyers involved in rent to own, or lease to own situations where the seller had apparently not been making the mortgage payments on the property and subsequently the property was foreclosed and the renter (buyer) LOST the equity they assumed had been set aside for the future.

In one buyer rent to own situation the party had improved the property and spent over $40,000 on improvements.  He was blown away and frantic when he came home one day to find the foreclosure notice on the front door.  I have run into this on multiple situations where the owner (seller) was using the rent, not to pass the money through to the mortgage company, but supposedly using the rent to own payments as an income stream.

I had a call from another woman who was wondering about a property she was thinking of renting.  It was going to be $5,000 upfront to move into the house.  I found the property in preforeclosure situation and passed this information along.  She really liked the house and thought it was a good deal and rented it anyway.  Humnnnn.  

Susan, I am guessing that all of the horror you mention adds up to why the State of Texas will NOT allow us as Realtors to do these lease or rent to own, or Lease/Purchase transactions.  We are told "hands off."  Send it to an attorney.  And your stories show exactly why that is best.

I don't think it works for either side.  The market is too volitale.  If it goes down the buyer walks.  If it goes up as a seller I loose all that equity.

I purchased my FIRST piece of real estate IN HAWAII in the mid-70s on a lease-option that CLOSED as an agreement of sale (I had equity and not title) and I subsequently purchased 3 more properties in a similar manner....purchasing with a conventional mortgage did not happen for almost 20 years later....great way to start if there is a good option for conversion and title

Very interesting post, and very interesting comments. What a variety of experiences!

Thanks George, very insightful post. Lease option down-payment credit definitely has no value for the buyer in these types of transactions. However, it does look like the seller (landlord) greatly benefits financially if the renter (potential buyer) walks. --Coach

Thanks George. I am in school and just found this post. It sounds like it is very likely to not be a great deal if the market goes down. If it goes up, the rent would have to go up as well to benefit the buyer and the only benefit is tying up their money in an average over the market rent which they could do on their own. If the buyer seeks a conventional loan, they may be able to agree on better terms and get a better deal. It does still seem that there is a benefit to the buyer if the market goes up but the option to purchase remains lower than the average purchase. This could also be a benefit to the buyer if the amount over the fair rental amount is credited to them and applied so long as the rate of appreciation outweighs the rate of return on their savings. It is still a gamble for the buyer. It does not seem that there is a true benefit to the seller. The seller would be able to liquidate the property lower than market if it goes up. Also, they may have to repair things caused by the lessee/buyer while the lease was in place to satisfy FHA and Fannie Mae requirements. The other downside to the seler is that the optionee can walk if the market goes down even if they collect an excess of rent unless that excess outweighs the difference in the downswing.