How Does a Lease Option to Buy a House Work?

By Business & Finance Last updated Saturday, June/01/2024

Monthly Rent

In a lease option to purchase, the tenant pays rent to the landlord, similar to any rental agreement. The difference is that a portion of the rent payment goes toward a credit to buy the house. If a buyer pays $2,000 per month in rent, and the lease option stated that he receives a 50-percent credit on his rent payment, $1,000 of his rent becomes a credit each month for the term of the lease. If the lease term is 12 months, he builds up $12,000 in credit toward the purchase of the house.

Lease options do not come without extra fees. The buyer must have a lease option payment equal to 2.5 to 7 percent of the purchase price of the house at lease signing for a seller to consider the contract. Consider this like a down payment. At 2.5 percent, however, that is still less of a down payment compared to other conventional loans. The option consideration money is nonrefundable and is not a security deposit, but it does apply directly toward the sales price of the home, in addition to the rental credits.

Leases with option to purchase terms are negotiable and depend substantially on the amount of time the buyer and seller want to engage in a rental transaction. A typical lease option period is three years, but lease terms can continue for longer durations if necessary. At the end of the term, the buyer provides funds or adequate financing for the balance. Using the example above, on a home with a sales price of $200,000 subtracting the buyer's $12,000 rent credit and 2.5 percent option fee of $5,000, the balance due the seller would be $183,000. That would be the amount the buyer needs to finance or pay in cash when the lease term is up.

Lease options offer clear benefits to buyers and sellers, especially in a depressed real estate market, when selling a home becomes a difficult proposition. In contrast to merely renting, the seller has peace of mind that the buyer has pride of ownership as he earns equity in the property, making him less likely to damage the property and become an expensive drain on the landlord. Thus, lease options as a rule are a win/win for all involved.