Rent-to-Own Agreement

Last Updated: January 23, 2023 by Robert Bailey

A Rent-to-Own Agreement is a lease agreement between a landlord (lessor) and a tenant (lessee) to rent a property with the option to purchase the property before the lease agreement expires. It contains both a standard lease agreement and language on how and when a tenant can exercise an option to purchase the property.

Why Use a Rent-to-Own Agreement?

A Rent-to Own Agreement has the following benefits:

  • Current Market Conditions – It might be a tough seller’s market. Leasing a property under a Rent-to-Own Agreement might entice buyers that are not quite ready to purchase a home but are planning to soon.
  • Lower Costs – This agreement can provide landlords with the potential sale of a property without having to hire a real estate agent or market the property.
  • Income – Instead of receiving no income while trying to sell a property, a landlord can enjoy a steady income without having to deal with the cost of maintaining the property. If the tenant decides not to exercise the option, the landlord can keep the escrow funds and option fee provided by the tenant.
  • Tax Advantages – There may be certain tax advantages for a landlord with negative cash flow to receive a steady stream of income for a time rather than just a lump sum payment from the sale of the property.
  • Finance Issues – A tenant may want to purchase a home but cannot obtain a mortgage due to their credit score, down payment amount, or other reasons. This agreement gives the tenant time to get their finances in order while locking in an option to buy a home.
  • Flexibility – If a tenant decides they do not want to purchase the property at the end of the option term, or they are unable, they can decline the option and end the lease just as you would with any other lease agreement.
  • Equity – It provides tenants the unique opportunity to build equity in a house before even owning it. In addition to the extra rent payment being held in escrow, a tenant can build equity by making improvements to the property if they are responsible for maintenance and repairs.

    Drawbacks of a Rent-to-Own Agreement

    While there are many good reasons to enter into a Rent-to-Own Agreement, there are some potential drawbacks as well. Those include:

    • Landlord Inflexibility – Once a landlord enters into this type of agreement they cannot refuse to honor the option or decide to sell the property to another individual. This can be especially frustrating if the market value of the property increases more than expected and the purchase price is already set.
    • Market Conditions – If the landlord uses the current market value for the purchase price there is little risk. However, if a landlord sets the price at the time of the agreement, they could potentially end up selling the property below market value. There is also the potential that market conditions worsen and the buyer declines the option leaving the landlord to find a new buyer for a lower price.
    • Tenant Actions – Unlike a traditional lease agreement, tenants are usually responsible for maintenance and repairs. If they do not maintain the property well and decline the option a landlord will have to deal with the repairs and a potential lawsuit to recoup their expenses.
    • Tenant Financial Loss – If a tenant is unable to move forward with the option to purchase they will likely lose any money paid as part of the Rent-to-Own Agreement. This includes the portion of the rent set aside for the purchase as well as the option fee.
    • Loss of Option – Some agreements have strict conditions that can result in a tenant losing their option to purchase the property. This can be triggered by a tenant not notifying the landlord in time or even being late on a rent payment. As a result, the tenant can lose the option fee, extra rent, and the cost of any improvements made on the property.
    • Landlord’s Finances – To an extent, a tenant is reliant on the landlord during the lease to continue to pay the mortgage and taxes. If they fall behind they could lose the property, which takes away the tenant’s opportunity to purchase the property.

    Additional Things to Consider

    With the unique nature of a Rent-to-Own Agreement, there are also some additional considerations for both the landlord and tenant:

    • Complexity – This agreement can be complex considering it also involves the potential sale of real estate. For instance, with these agreements, in addition to lease-option contracts (which give tenants the right to buy the home), there are also lease-purchase contracts (which require the tenant to buy it). The difference between these terms is significant and another reason to have an experienced professional assist you in reviewing the agreement.
    • Due Diligence – For tenants, before exercising the option to purchase, take the time to ensure there are no major red flags. It is recommended to get the home formally inspected, check that the property taxes are current, and get an appraisal. Also compare prices with other houses recently sold in the area and the seller’s history, if available.
    • Disclosures – Certain states require landlords to disclose information about the condition of the property when a tenant has an option to purchase the property. It is important to know what you are required to disclose when you sell your home.

    What to Include in a Rent-to-Own Agreement

    A Rent-to-Own Agreement contains much of the same information that a standard lease agreement includes. However, there are some major differences and it is important to understand them before preparing your Agreement. Those include:

    • Option to Purchase – The most obvious difference is that a Rent-to-Own Agreement allows you to purchase the property you are leasing by exercising an option to purchase.
    • Terminology – This is still a lease agreement so there is still a landlord and tenant. However, the tenant is also considered the “buyer” and the landlord, in most instances, is also the “owner.”
    • Rent Payments – Rent-to-Own Agreements usually have a higher monthly rent than the current market rate. A portion of the rent is typically set aside in escrow which the tenant can use towards the purchase price of the property.
    • Option Fee – An upfront fee is typically required when a tenant has the option to buy the house at the end of the lease. These fees can vary and are negotiable but usually, they end up being approximately 1-5% of the agreed purchase price.
    • Property Maintenance – While typically a landlord’s responsibility, many Rent to Own Agreements require the tenant to maintain the property and pay for repairs. Since this is different from traditional lease agreements, the clause should clearly state the tenant’s responsibilities. It’s also essential that the parties conduct an inspection before the start date of the lease. A Move In Checklist is a great resource for ensuring a thorough inspection.

    Essential Terms and Conditions

    The following terms and conditions are essential:

    • Lease Terms – The length of the lease.
    • Payments – Include all payments and potential fees you will be requiring from the tenant, how they should make those payments, and when they are due.
    • Option Terms –  This includes the period in which a tenant can exercise their option to purchase the property, what steps a tenant must take to exercise the option and the purchase price (or how it will be calculated).
    • Signatures – Without signatures from both the landlord and tenant, the agreement will have no legal effect.

    Specific Items to Include in a Rent-to-Own Agreement

    Here are the specific items you should include and a brief explanation of their purpose:

    1. Date – The date the agreement is signed and goes into effect.
    2. Parties – This will include the landlord/owner and the tenant/buyer that will be bound by the agreement. It should also include the address for the landlord and the current address for the tenant.
    3. Property – Provide the full property address at the beginning of the agreement. You may also want to include what type of property it is and the number of bedrooms and bathrooms.
    4. Option to Purchase – This is a general clause that indicates that this agreement provides the tenant with the option to purchase the property.
    5. Exclusivity of Option – The Agreement must state that the option to purchase is exclusive to the tenant signing the agreement.
    6. Option Consideration – This clause provides details on the fee a tenant pays for the option to purchase the property and whether it will apply to the purchase price of the property.
    7. Option Term – This is the timeframe in which the tenant has to decide whether or not they will purchase the property.
    8. Tenant Notice to Exercise Option –  Provides the details on how the tenant has to provide notice to the landlord to exercise the option.
    9. Purchase Price – This clause provides specific details on the purchase price and how it will be determined.
    10. Closing and Settlement – Provides details on finalizing the purchase such as the title company, settlement location, and responsibility for costs.
    11. Title – This clause details delivery of the title and specific details such as providing a preliminary title report.
    12. Financing Availability – The agreement should make clear that it is not based on any agreements about financing and that the tenant is solely responsible for this aspect of purchasing the property.
    13. Default – Details the impact of a tenant’s default and the landlord’s rights if a default occurs.
    14. Commission – There should be no commission paid if the tenant decides to purchase the property. All fees are already included in the agreement.
    15. Lease Term – The agreement should include the start and end date of the lease term.
    16. Rent – Include the amount due each month, the date it’s due, and the method the tenant can use to pay their rent (e.g. check, online transfer, etc.). It should also indicate whether the tenant must pay the first month’s rent when signing the Agreement and detail how the money will be held in escrow for the purchase of the property.
    17. Late Rent – This clause should include details on what will occur for late rent payments. Just be aware of state laws as it applies to the amount of a late fee you can charge and whether or not there is a required grace period. Click here for more information on handling issues with past-due rent.
    18. Insufficient Funds – Indicate any fees required for rent that are not paid due to insufficient funds.
    19. Security Deposit – A security deposit is a reimbursable deposit used to protect the landlord in case a tenant violates the lease or causes damage beyond normal wear and tear to your property. Include the amount required for the security deposit (usually equal to one month’s rent) as well as what items can be deducted from the security deposit. In this clause, you should also include when the security deposit will be returned to the tenant. Click here for specific information on your state’s security deposit laws.
    20. Utilities – Landlords should list the utilities that they will provide and inform the tenant that they are responsible for setting up and paying all other utilities.
    21. Smoking Policy – Since a landlord may not sell the property, indicate whether or not smoking is prohibited.
    22. Occupancy Limit – Include the maximum number of people that can stay at the property. This clause can be more specific by listing the number of adults, children, and babies that will be living at the property.
    23. Pets – This clause should indicate your pet policy. If you allow pets your agreement should indicate what type of pets are acceptable, how many, their maximum weight, and if there will be a pet fee. If there is a pet fee the landlord should indicate whether it is refundable or not.
    24. Trash Disposal – Specify how tenants should dispose of their trash during their lease term. This should also include the trash and recycling collection days.
    25. Quiet Hours – This clause will indicate whether or not there are quiet hours. If there are quiet hours this clause should also specify what those specific times are and what’s not allowed during this time.
    26. Parking – This should inform the tenant whether or not the agreement will include parking. If included, provide any necessary details such as the number of parking spaces and the location of the parking spaces.
    27. Keys –  This clause should provide the location where the tenant will pick up the keys to the property.
    28. Person of Contact – For this clause, indicate whether the landlord has a manager on the property and provide their contact information. If not, indicate that the tenant can contact the landlord for any emergency or concerns.
    29. Subletting – Indicate whether or not you will allow the tenant to sublet (grant license to other individuals to use) your property or not.
    30. Move-In Inspection – This clause provides that a joint move-in inspection will be conducted between the landlord and tenant.
    31. Landlord Entry – There may be a time when a landlord will need to enter the property the tenant is renting. Make sure there is a clause that highlights the amount of notice a landlord will provide the tenant as well as the allowable reasons to enter the property.
    32. Maintenance and Repairs – Unique to Rent-to-Own Agreements, this clause will usually place the responsibility of the performance and payment of all maintenance and repairs on the tenant.
    33. Quiet Enjoyment – The landlord promises that the tenant will be able to peacefully enjoy the use of the landlord’s property. This clause also requires the tenant to ensure that their neighbors can peacefully enjoy the use of their properties as well.
    34. Liability – You should detail the liabilities for both the landlord and the tenant.
    35. Attorneys’ Fees – This clause requires the tenant to agree to pay the landlord’s attorney fees if they violate the agreement and the landlord is required to take any action as a result.
    36. Use of Property –  The property should be for residential use only and should explicitly prohibit the tenant from using it for any type of commercial activity.
    37. Illegal Activity – This clause informs the tenant that any illegal activity is grounds for termination of the agreement.
    38. Possessions – This clause will detail what the landlord will do with any personal possessions that have been left behind by the tenant.
    39. Hazardous Materials – This clause prohibits tenants from having certain dangerous materials in any portion of the property. Specific exceptions are provided for items needed for cooking or operating an appliance located on the property.
    40. Compliance with Law – This clause requires the tenant to abide by certain local codes.
    41. Notices. This clause indicates where all notices should be sent for both the landlord and tenant.
    42. Possession & Surrender – This clause lays out both the right of the tenant to possession of the property at the start of the lease term as well as the obligation to surrender the property at the end of the lease term.
    43. Termination – Provides the landlord’s rights to terminate the agreement and reclaim the property.
    44. Joint and Several – All tenants are liable for the actions of any other tenants. This clause holds all tenants that are part of the agreement liable for the actions of any other tenant.
    45. Lead-Based Paint Disclosures – This clause will indicate whether or not the property was built before 1978. If built before 1978, there is a requirement for the landlord to provide a Lead-Based Paint Disclosure.
    46. Governing Law – This will indicate which state’s laws will govern this agreement and where any disputes will be held.
    47. Waiver – This clause explicitly states that just because a landlord does not properly enforce any part of the agreement, it does not mean that any part of the agreement has been waived.
    48. Severability – If any provisions are determined invalid, it does not impact other valid provisions in the agreement.
    49. Recording of Agreement – This clause restricts the tenant from recording the agreement on a public record.
    50. Additional Provisions – There may be clauses you want to include that are specific to your situation. Our template provides a clause to insert additional provisions.
    51. Entire Agreement – The agreement and any attachments are considered the complete agreement. Any prior negotiations or understandings, written or oral, are null and void.
    52. Acknowledgments – Provides various acknowledgments for both parties.
    53. Signatures – All parties must sign this agreement. These signatures are what make the agreement officially binding. If there is an agent involved they should sign this agreement and you should also have a witness to verify both parties freely signed the agreement.

    Additional Items to Include with the Rent-to-Own Agreement

    Depending on the state your property is located, you may be required to provide additional disclosures and addendums. Besides the specific content above, here are some additional items you may need or want to include:

    1.      Lead-Based Paint Disclosure
    2.      Asbestos Disclosure
    3.      Bed Bug Addendum
    4.      Pet Addendum
    5.      Carbon Monoxide and Smoke Detector Addendum
    6.      Flood Zone Disclosure
    7.      Mold Disclosure
    8.      Shared Utilities Disclosure
    9.      Move In Inspection Checklist
    10.      Move Out Checklist

    It’s a good idea to have a separate cover page listing the disclosures and addendums that are part of the agreement. This will help avoid confusion as to what additional documents are part of the agreement.

    Final Things to Consider

    1. Understanding Key Terms – Lease agreements, including a Rent-to-Own Agreement, may contain some legal terms and words that are unfamiliar. If you have any questions, it is a good idea to have an attorney review the document and help you better understand your rights and obligations.
    2. Keep a Signed Copy – Both the landlord and all tenants should keep a signed copy of the agreement.

    What’s Next?

    After all of the parties have reviewed the agreement here is what’s next:

    • Sign the Agreement – Depending on a tenant’s financial history, a landlord may require a cosigner for your lease. To strengthen the validity of the agreement, it should be signed in front of witnesses or even a notary.
    • Keys – Once the agreement has been signed a time can be scheduled for the landlord to hand over a set of keys to the tenant.
    • Payments – The tenant must make sure that they provide the landlord their security deposit, option fee, and any other payments listed in the agreement.
    • Move-in Inspection – Before the lease begins, landlords should schedule a time to conduct a Move In Inspection with the tenant. Using a Tenant Move In Checklist, this inspection should document the condition of the property. This inspection will ensure that the property is in good condition for the tenant and that the tenant has a clear understanding of the landlord’s expectations for the property.
    • Move-in Day – While most information should be in the agreement and Tenant Welcome Letter, the landlord should make sure they are available to assist the tenant if they have any other questions or concerns.
    • Option –  At some point, as provided in the agreement, the tenant will have to decide whether or not they want to purchase the property. If they decide not to purchase the property, the landlord should follow the terms of the lease agreement and their state’s laws as it pertains to either terminating or renewing the lease.

    At some point, if the option is exercised, the parties will move forward with the actual sale of the property. This will involve some additional steps:

    1. Inspection – Despite already living at the property, a tenant will likely have the opportunity to have a professional inspection.
    2. Negotiate – While the price may already be set, there may be the need for negotiations if there are previously unknown defects found on the property.
    3. Financing – The tenant will have to make sure they can secure a mortgage or some other form of financing. For landlords that do not have a mortgage on the property, it is often common for the landlord to convert the lease into a purchase agreement with owner-financing.
    4. Closing Date – This is the date when all obligations must be met by both parties and the property is officially transferred to the tenant.