Definition
A lease option, also called rent-to-own, is a real estate contract that allows a tenant to lease a property with the option to purchase it at a predetermined price before the lease term expires. The tenant typically pays an option fee upfront and may also contribute extra rent toward the future down payment.
Explanation
Lease options are designed for buyers who may not qualify for a mortgage immediately but want to secure a home purchase in the future. These agreements include:
- Lease Agreement – The tenant rents the home for a set period (typically 1–3 years).
- Option to Buy – The tenant has the exclusive right (but not obligation) to purchase the property before the lease expires.
- Option Fee – The tenant pays an upfront, non-refundable fee (usually 1%–5% of the home price) for the right to buy.
- Rent Premiums – A portion of monthly rent may be credited toward the future purchase price.
If the tenant decides not to buy, they lose the option fee and any rent credits paid.
Pros and Cons of Lease Options
✅ Advantages:
- Allows tenants time to improve credit or save for a down payment.
- Locks in a purchase price even if home values rise.
- Provides a test period to live in the home before committing.
❌ Disadvantages:
- The option fee is non-refundable if the tenant does not buy.
- If home prices fall, the buyer could overpay.
- The seller may still require mortgage approval at the end of the lease.
Example
A tenant signs a 2-year lease option agreement for a home priced at $300,000 with an option fee of $6,000 (2%). They pay $2,500 in monthly rent, with $300 credited toward the down payment.
After two years, they can apply for a mortgage and buy the home, using the $6,000 option fee and $7,200 in rent credits ($300 × 24 months) toward their down payment.