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20 September 2004, 3 October 2005
Postscript
What Is a Lease-to-Own 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, 1% to 5% of the price, 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 both the option fee and the rent premium.
As with any kind of financial contract,
lease-purchase deals can be structured in such a way that all the benefits flow
to one of the parties and none to the other. Buyers especially need to be
careful. But lease-purchase plans have a solid economic rationale, which means that they can
be structured so that both parties benefit.
Contract Features
of a Lease-Purchase
A lease-purchase has 5 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 often know less about the market than sellers, which
places buyers at a disadvantage unless they do some homework, which is
advisable.
Buyers generally prefer a long
option period because it provides more time to build equity 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, in addition to the 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.
Using a
Lease-Purchase to Buy
The lease-purchase offers homeownership opportunities to consumers with little cash and/or poor
credit, 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.
The development of the
sub-prime market, in which consumers with poor credit or no cash can obtain
loans, does not seem to have lessened interest in lease-purchase. It is very
likely that those who succeed in exercising their option under a lease-purchase do better than if they
had financed a conventional purchase in the sub-prime market. The savings in
finance costs will more than offset a higher price on the house. But those who
can�t exercise their option will lose their bets.
Consumers who need to rebuild their credit
rating during the option period should understand that paying their rent on
time won�t do it. Rent payment information is not used in compiling credit
scores. While Fair Isaac, the company that developed credit scoring, has
recently unveiled an �expansion� score based on �non-traditional
credit data,� it does not yet include rent payment information from individual
home owners. Lease-purchase buyers who need a higher credit score must focus on their
credit cards and loans.
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 sale.
Using a
Lease-Purchase to Sell
Most home sellers want a cash sale, but for those prepared to hang on to the
property awhile longer, the benefits can be compelling. Bob Bruss, an expert�s
expert on lease-purchases, says that in this market, there are always more buyers than sellers � he has
been both. As a result, buyers generally pay top dollar, perhaps including some
assumed future appreciation.
To be sure, the deal may fall
through, but in that case the seller gets to pocket the option fee and rent
premium. The seller also enjoys the tax deduction on his mortgage interest
payments during the option period.
3 October 2005 Postscript: Read the Contract!
On October 2, 2005, Bob
Mahlburg, an investigative reporter for the Sarasota Herald-Tribune, published
an article on a substantial lease-to-own program in Florida that had generated
numerous complaints. Over a 5-year period hundreds of deals were executed under
this program but only a handful of purchases. In fact, there were more evictions
than purchases.
The contract used in this
program made it all too easy for the seller to avoid having to sell when it was
more profitable to evict the tenant and do another deal with another hopeful
buyer. The moral: read the contract very carefully to make sure you are
confident you can live up to all the terms, such as paying your rent on time,
every time.
Copyright Jack Guttentag
2005 | 
