Lease-purchase arrangements are receiving renewed attention from legislators looking for ways to make homeownership more accessible, and they’re a great way to help buyers who can’t qualify for a traditional mortgage or pony up the money needed for a down payment. But that doesn’t mean there aren’t risks involved for potential purchasers. The Pew Charitable Trusts decided to investigate the pros and cons of what can be an invaluable tool for some potential homeowners.
What Is a Lease-Purchase?
A lease-purchase, also known as “rent-to-own” or “lease with option to purchase,” is a form of alternative home financing—a mechanism that potential homebuyers might consider when traditional credit is not immediately available to them. Under a lease-purchase arrangement, the property seller also acts as the landlord. The buyer rents the home as a tenant first, typically paying an up-front fee or down payment under an option contract to preserve the right to purchase the property within a set time period. Sometimes, during the rental period, the buyer is required to put aside some savings every month toward the home purchase. The seller transfers the deed to the buyer once the buyer obtains a mortgage to purchase the home.
A lease-purchase agreement consists of two components: the lease or rental agreement and a separate contract that allows the buyer to purchase the property within the rental period. Properly created and executed, lease-purchase arrangements can help prospective buyers improve their credit scores and save for a down payment while living in a home of their choice, ultimately leading to them becoming homeowners. While the agreements work well for some potential buyers, others do not become homeowners when they conclude their rental agreements, even paying more than the median rental price in monthly payments or losing a portion of their savings put aside for the home purchase to fees if they decide to walk away from the arrangement.
Lease-Purchases vs. Land Contracts
Lease-purchases are different from land contracts, another alternative home-financing tool, which help buyers with no access to traditional credit. (Whereas the appeal of lease-purchases is that buyers can get more time to obtain a conventional mortgage, or want to lock in a price in a competitive housing market.) Land contracts offer a quicker closing and lower up-front expenses than a mortgage, but some buyers and news articles have reported evictions or loss of payments made.
Market Embraces Wave of Business Players
About 2.4 million adults living in 1.2 million U.S. households use lease-purchase agreements, with the agreements having an estimated total value of $196 billion, per Pew’s surveys about alternative financing in 2021 and 2022. So it’s not surprising that financial technology (fintech) companies and other investors have turned to the lease-purchase market in recent years, focused on buying single-family homes.
Majority of Lease-Purchase Borrowers Make Payments to Non-Family Entities
Over half of lease-purchase borrowers surveyed make payments to nonrelatives, companies, or organizations they do not know: 30% pay an individual or a family not related to them, while 25% pay a business or company; 25% pay a family member; and 15% did not know whom they pay for housing.
Gaps in State Laws Leave Lease-Purchase Borrowers in Limbo
An estimated 6% of home borrowers in the United States have used lease-purchases, but state laws don’t treat such arrangements uniformly. Worse, the distinct two-part structure of lease-purchase arrangements often confuses buyers about applicable consumer protections. For example, the sellers, usually also the landlords, are generally responsible for keeping the property safe and livable for tenants. During the rental period, lease-purchase agreements tend to be governed by state landlord-tenant laws.
But if/when prospective buyers decide they want to exercise their option to purchase the home at the end of their rental period, they would be covered by state and federal mortgage protections post-purchase. But it’s that in-between phase that’s tricky: few state or local laws govern the option contract in a lease-purchase arrangement until the renter formally purchases the home.
Click here to read more on Pew’s analysis of lease-purchase agreements.
