Scott Elliott, real estate agent with RE/MAX writes about the potential pitfalls of lease-to-own transactions.
As a real estate agent, I’m often asked by buyers whether a particular seller would consider a “lease-to-own” arrangement for their property, be it a home, condo or land. This is due to the fact that during these tough economic times, many buyers do not have enough money saved to make a down payment or qualify for a bank loan.
Typically the arrangement suggested is that the owner rents the property to the buyer and in the lease the buyer is required to buy or given an option to purchase the property for a predetermined price at the end of the lease. Part of the rent paid monthly is then credited toward the down payment and deducted from the purchase price. On the surface, it seems like a mutually beneficial agreement for both parties – the property owner gets an immediate revenue stream and has a deal to sell the house, and the buyer can save up for the down payment via the rental payments and build their credit over time.
While the rent paid acts as something of a forced savings plan for the tenant, and does give some people a way into the market, leasing to own does have pitfalls for the buyer depending on how the arrangement is structured. For example, the buyer may still be required to pay a deposit to the owner, and such deposit may be forfeited, along with all of the rent paid, if the buyer is unable to complete the purchase at the end of the lease. Also, in most rent-to-own scenarios, the buyer pays higher than market rent, so if the buyer is unable or unwilling to complete the purchase, then essentially the amount paid above market rent has been wasted.
For example, a homeowner wants to sell for $200,000. The house rents for $1,000 a month. After a $5,000 deposit, a rent-to-own tenant might pay $1,300 a month in rent – with $300 of each payment as a credit towards the down payment. On a three-year lease, the tenant would have paid $10,800 towards the down payment. Add those credits to the initial deposit, and the renter will have $15,800 for a down payment. This can be attractive for those who can afford to buy a home, but might not quality for a mortgage. Their hope is that, by the end of the lease, they will be able to qualify for a traditional mortgage from a bank. Additionally, depending on how the lease to own contract is written, in some cases the contract may be terminated if the rent is late at any time – meaning not only do you get evicted, but you could also potentially lose tens of thousands of dollars.
Another thing to consider is that if the lease is not registered, the buyer has nothing on title protecting his interests. The buyer is free to register the lease, or a caution, but if the terms of the agreement are that the buyer is required to buy at the end of the lease term (rather than simply having an option to buy), then under the Stamp Duty law the agreement confers a right of possession and stamp duty is payable on the purchase price now, not at the end of the lease. A huge upfront cost.
From the seller’s point of view, there are also pitfalls. For example, there is no guarantee that after the lease is finished that the buyer will exercise the option to buy. Or even if he wanted to do so, the buyer still might not be able to qualify for a bank loan. If that is the case, the owner has effectively removed his property from the market for several years, lost the opportunity to find other more qualified buyers during that time and now has to start marketing it for sale all over again. Also, the property may have increased in value substantially during the term of the lease, resulting in a windfall for the buyer when he exercises his right to buy at the price agreed years ago.
At the end of the day, given the risks involved, it may be better for the seller to try to find a buyer already qualified for a loan and for the buyer to rent and wait until he can qualify for a traditional mortgage. Given the government’s initiative in 2011 allowing private sector Caymanian buyers the ability to tap into their pension funds up to $35,000 to fund their down payments, I would rather see a buyer take advantage of that option and (as required by the programme) then pay it back gradually over time, rather than jump into a rent-to-own scenario. In this way, the buyer is still in control of their money.
However, if you do decide to enter into a rent-to-own agreement, I strongly recommend that you retain an attorney to review any contract and explain the pros and cons before you sign on the dotted line. Compared with the cost of the legal fee (probably $500 or less) for reviewing the contract up front, it could cost you tens of thousands of dollars for a mistake.
As with any real estate transaction, tread carefully and as always, buyer beware.
Scott Elliott is a real estate agent at RE/MAX Cayman Islands and can be reached at 943-6001