An option to buy is a real estate contract in which someone is given the right to exercise a buy option within a certain period of time. Options to buy are often bundled with rental contracts, and people may refer to a “lease with option to buy” or “rent to own” agreement. These contracts can be useful for both buyers and sellers, depending on the market, but they can also be an unwise financial decision. It is important to evaluate the terms carefully before signing.
In the classic scenario of a lease with option to buy, at the start of the lease, renter and landlord agree on the terms. It might be a two year lease-option, which means that the renter/buyer has two years to decide whether or not to buy the property. Typically a lump sum known as option money is paid up front by the buyer to secure the option. The buyer pays rent, and at the end of the term, has an option to buy the property or not.
If the renter opts to become the buyer, the home is sold as it would be normally, with a series of inspections to confirm that the property is in good condition, a down payment, and financing, assuming that the buyer cannot pay cash. If the buyer forfeits the option, the option money will be lost. It's important to be aware that it can take 45 days or more to close on a house, so buyers shouldn't wait until the last minute to exercise the option.
Renters often find the lease with option to buy appealing because they think that they will be able to save money for a down payment within the terms of the lease. However, many find that when the option comes due, they don't have the funds, or cannot qualify for a loan. This is something to consider before entering into a lease with option to buy, especially when option money is involved.
On the flip side, renters may find that real estate values have risen while they rented, and they can exercise the option and then resell the house for a profit. This, of course, is the danger for property owners who enter into a lease with option to buy agreement. In a slow market it may be tempting to lock in a potential purchase price, but if the real estate market heats up, the property owner is locked into the original price and may take a loss.
Both sides of the agreement should have lawyers review the terms carefully and make sure that they fully understand their risks and obligations.