What Is A Lease To Own Contract?
In the realm of Texas real estate, lease to own contracts, also known as leases with an option to purchase, occupy a unique place in the market. They serve as a middle ground between a lease agreement and a purchase contract. Basically, these agreements establish a contract between a tenant and a property owner whereby the tenant pays rent and has the option to buy the property at a later date.
The basic structure is quite simple: the tenant/debtor makes a small down payment and pays monthly rent, with a portion of the rent amount going toward the purchase price. The tenant also has the option of purchasing the home at the end of the lease for the predetermined purchase price, or they can opt out and walk away from the deal at the end of the lease term . Some agreements may allow for a partial refund of their initial deposit, while others may not.
One of the primary advantages of lease to own contracts for property owners and investors is the ability to hold the legal title to the property until the sale closes, while still collecting monthly rent from the tenant. This means that the investor does not have to worry about a lengthy trustee foreclosure or code violations that an investor might experience under a conventional seller financed installment transaction. Lendors typically do not finance these types of transactions since the seller of the property (who is also the lender) does not legally hold the title to the property.
Legal Aspects of Texas Lease to Own Agreements
There is no outright ban on the use of lease to own contracts in Texas. But the law does regulate the use of lease to own contracts. These regulations were put in place to further protect consumers, and to inform them of exactly what they are getting into.
The Texas Property Code—specifically, Chapter 93—regulates lease to own contracts. Although all lease to own contracts must be in writing, it is not enough to simply print the terms of the contract and have the consumer sign it. The lessor must also provide a copy of the Truth in Lease to Own Statement. This statement contains a series of disclosures that the lessor must communicate to the consumer, including and not limited to the following:
- The monthly installment amount
- The total amount of all scheduled payments over the course of the contract
- The finance charges
- The cost to purchase the property
- That the consumer is entering into a lease to own contract rather than a retail installment contract, and that the consumer will not get the property until after all the payments have been made and the consumer has signed a bill of sale or such other document
- That the consumer has the right to purchase the property at any time before the final payment is due
The lessor must have the Truth in Lease to Own Statement on file at the office of the lessor, and must give the consumer a copy of the statement at the time of the lease to own contract is executed. If the lessor has more than 50 locations, he or she may exchange the Truth in Lease to Own Statements electronically.
Benefits Of Lease To Own Contracts
As previously noted, there are specific advantages for tenants in Texas who buy a house via lease to own contract. The agreement generally makes it easier to purchase land if the tenant has a poor credit history or cannot afford a substantial down payment necessary to purchase a home directly from a landlord.
Additionally, landlords benefit from lease to own contracts because they avoid many of the headaches involved with traditional renting or leasing, such as unruly or negligent tenants who do not properly pay rent, or cause damage that is difficult to recover. No one wants to buy a house that is in disrepair in order to make a profit from leasing it.
While renting out a home can leave a landlord with more money each month, owning the home might be better in the long run. Doing so might also help a tenant understand that money spent living in the temporary arrangement can be used towards paying for their own home in the future. A lease to own contract can provide financial security within a formalized contract, unlike a verbal agreement.
Drawbacks And Risks Of Lease To Own Agreements
Potential risks and challenges are associated with lease to own contracts in Texas. One of the biggest pitfalls can be financial. If the property is not well maintained or the lessee fails to pay the rent on time, the landlord could lose potential value to future tenants. This scenario forces landlords into the role of unpaid landlords, reducing the motivation to maintain the property to a high standard. Renters should also ensure that they have the necessary funds to purchase the property at the end of the lease. If they do not have sufficient funds, they may lose both the property and the money that they have put into it.
Another problem is that if the property is damaged, the landlord may not have the necessary cash to make repairs. This situation puts the lessee at risk for purchasing a property that is in poor repair and may require more substantial investments. Related to the financial issue, the tenant may be stuck renting a property that is worth much less than when they first moved in. If the housing market in that area goes down, the lessor could be forced to buy a property at an inflated purchase price. The best way to avoid these financial risks is for both parties to be sure that there is sufficient money in reserve to cover any damages and that they have a reliable way to access that money.
There are legal considerations as well. Both parties should be familiar with all local, state and federal laws pertaining to rental agreements . Failing to obey these laws puts both the tenant and the landlord at risk for any legal problems that might arise. In most instances, these laws will center around finances, requiring the surrender of security deposits to the tenant once the lease is over. It is best for both parties to have their attorneys look over the lease before signing.
Landlords should consider whether the property is properly zoned or if it could be at risk of upzoning. Upzoning refers to changing the way a property is classified under zoning law. For instance, an industrial property may be reclassified as residential. A property may also be subject to imminent domain, meaning that the government can purchase the property at its assessed value. If something unfortunate like this happens, the landlord must decide whether to sell the property at the assessed value or take the chance and remain in the upzoned property.
One of the greatest problems with lease to own contracts in the state of Texas involves the market. With a property as significant as a house, it is essential that there is enough demand. If there is not enough market demand, a number of problems can arise. Both parties can lose money and/or the property could sit vacant for a long period of time. If it sits vacant, the owner could end up having to pay taxes and upkeep costs out of pocket. Additionally, the property may not have the same protections for personal property as it would under a traditional lease. Without a traditional rental agreement, the lessor could lose their personal belongings.
How To Write A Lease To Own Contract
In creating a solid lease to own contract, there are several key sections and important terms that you should consider including. We’ve outlined some of these below.
Deposit and Rent Payments
You should include details as to how much the option deposit is, where payments will be made (e.g. by mail or delivered in person), how payments will be tracked within your records, and a mechanism for which you can increase the rent amount. A provision that allows you to increase the rent if the taxes on the property increase is a good idea, too.
Options
You should include details on where the option amount will be deposited, when you will sell the property and how and if the option amount changes should the sale not occur before the end of the lease period. A clause explaining that you make no warranty as to the sale or exchange of the property is also helpful.
Maintenance and Repairs
Making a provision stating who is responsible for repairs is important. In cases where you have a single family rental home, the tenant will most likely make repairs to the property. Having options for you to make repairs and bill them to the tenant is wise, as well.
Utilities and Insurance
Include provisions as to your expectations for insurance and utilities. Be as specific as possible in this section, as it may help make or break a deal.
Default
Defaults are part of life and should be anticipated and included. Include the costs of dealing with a default along with a manner in which a good faith effort can be measured should it be necessary.
Terminating Lease To Own Contracts
Ending a lease to own contract in Texas can take place by completion of the purchase or termination. By far the most common way to end a lease to own contract is for the buyer to complete the purchase. Upon completion of the purchase, the seller would simply give the buyer title to the property. However, as mentioned previously, many of these contracts contain unenforceable terms that are in most cases unlawful . Upon discovery of these unlawful terms, the buyer may have a right to end the contract and potentially recover damages from the seller.
Further, depending on how the contract is terminated, the seller may be required to tender the purchase price back to the buyer. Finally, if there are multiple signers on the contract, one signer may be able to end the contract while the other(s) remain bound by the contract.