Looking for a new home can be stressful and, in many cases, coming up with a deposit on a mortgage can be hard work. For many people who are looking to move beyond renting but for whatever reasons cannot yet commit to a mortgage, then a rent-to-buy property may provide a useful in-between option. Also called a lease-option agreement, rent-to-buy real estate gives tenants the option to purchase a property during a specified period. During this period, the tenant pays rent above market rates and, if she ultimately does purchase the property, then a portion of that rent will be repaid to her by the landlord. While such an arrangement has benefits, it also comes with plenty of legal risks, three of which are described below.
The seller could lose the property
During the rental period the property will belong to the landlord and not the tenant. That means that if the landlord loses the property then the tenant could also lose his or her right to purchase the property. The landlord, for example, may be having financial difficulties and be falling behind on mortgage payments. If the property goes into foreclosure then the bank may give the tenant the first option to buy the property, but there is no guarantee of this happening. The seller could also lose the property due to other reasons, such as a divorce or a tax problem.
The market could decline
One disadvantage of many lease-option agreements is that they usually lock the tenant into a purchase price beforehand. This means that once the tenant decides to purchase the property, he will have to pay the price he agreed to when he first signed the rent-to-buy agreement. The risk here is that the market could go down during the rental period, meaning the buyer will end up paying more to purchase the dwelling than he might otherwise have done without a lease-option agreement.
Declined for a mortgage
Finally, there is no guarantee that a person who signs a rent-to-buy agreement will actually be able to get approved for a mortgage once he or she decides to purchase the property. By getting denied a mortgage, the tenant could be in a position where he not only loses the option to buy, but he has also paid above-market rent for a period of time which he cannot get back. Those considering a rent-to-buy property should talk to a mortgage broker to see if they are likely to be approved for a mortgage in the near-future.
Rent-to-buy agreements are a great way to “test drive” a property before committing to a mortgage. However, these agreements carry significant legal and financial risks for buyers and anybody who is considering such an agreement should research the potential pitfalls beforehand.