Rent-to-own Help!

51 Replies

I am beside myself trying to figure out what documents do I need to have for a rent to own agreement. I talked to a lawyer but he didn't seem to want to talk about what I needed. The first thing he said was "I don't think you want to do a RTO agreement". smh... So anyway.. people that have done RTO's before please help!! What documents do I need exactly. Should I have a Lease, a lease addendum, and a sales contract like the lawyer said? Or do I just have one lease and an addendum? What documents did you need/have to successfully do your Rent-to-own agreement? The only thing I have right now is a lease for the property. I really would appreciate it if someone could walk me through the steps I need to take and the documents I need to have. I already have a lease made up for the property but it is a basic standard lease for if someone wanted to rent the place.

Yes, I'm the seller. I just want to make sure I have all the documents I need for a RTO. I don't want to say the same thing over and over again in 2-3 different documents. I just need to know the down and dirty steps and documents I need. We have already agreed on a price to sell it at. I just need to know if the lease option takes the place of the Security deposit. Or do I charge them a security deposit like a regular rental and keep the lease option a different fee separate from the security deposit. Do I just need a Sales Contract, Lease, and an addendum to one or both? I currently have a lease for the property but we are trying to do an RTO so I don't know how I should work it. Is the rental credit optional? Do they have to pay extra monthly or do I credit them the amount off of the final price? If they want it off the final price do I up the final price so that I make the price of the house the agreed upon price? (e.i. we agree upon 130,000... but they want the rental credit taken off the final price... so do I up the final price to so that I still end up with the agreed upon 130,000? Do I make the sales contract separate from the lease? How do I word it so that I give the responsibilities of maintaining the house to the tenant... since in affect they are purchasing the house?

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Hi Jason,

You should decide first if you are going want a lease option, purchase option, or seller financing. It is such a broad subject spend some time reading what is best for you and the tennant buyer.

Terry Lewis

Your questions are too legally complex to answer from anyone but a lawyer.  I will offer a little insight. 

You need a state sales agreement, an option agreement, AND a rental agreement, tying them all together. It would be incomplete without all three.   You need concrete terms for the rental period, and the terms for the sales agreement, and the terms for the option.

I would charge a security deposit, much like a rental and give them the ability to credit the security deposit towards the purchase price when they exercise the option to purchase.  I would also change an earnest money, but you could elect to consider the security deposit the earnest money, just being very clear within the contract, the terms in which it would be refunded, or not refunded to the Buyer. 

I would also give them a due diligence period within the contract where they can have whatever inspections, appraisals, and title review BEFORE their occupancy date UNLESS you will not be particularly bothered if they do not exercise the option to purchase. 

YOU need to decide if you want to credit a % of the monthly payments toward the purchase price. A reason people may be interested in doing something like this is because that payment over a year, could minimize their down payment on the loan they select when they exercise the option. For example, if they are getting an FHA loan, their lender may be satisfied if they have paid 3.5% of the purchase price during the lease period. You could increase the purchase price, or just adjust the rental payments upwards with a larger % towards the purchase price.

The best thing in a lease option is to keep it simple, which is a total oxymoron because lease options are truly complicated AND high risk (for the Seller) in an increasing market.

@Jason Reynolds   if I can toss my 2 cents in here....in all due respect to @Kim Knox   and I mean that..forums are where people disagree..so..I'm about to disagree..sorry!!! 

You are the seller so you need 2 documents for a lease option. A lease and an OTP  Option to Purchase.  I would also recommend a Tenant/Buyers' acknowledgement (the CYA form that states they understand everything and they are not under duress etc)

THe lease states the terms of the lease. The option states the terms of the option. price, what they are paying down and the rent credit. (we call it a seller concession for the lenders) 

BTW! Search for my post "how to set the numbers on a lease option" That will help!!!

Also, do not...wait...all caps..DO NOT  get a deposit of ANY KIND!!!!

Everything you get is non-refundable. 

You don't get a deposit, you get option consideration that is non-refundable, and your OTP will state this. 

@Brian Gibbons   is the solid source for additional info....

Should I wait for Brian's post and then correct everything all together? Might be easier on me......

Just in case something happens to Brian......

Always us two separate Agreements, you lease and an Option to Purchase

Do your lease close to fair market value. You can have a security deposit and should, it is for a security deposit unrelated to the option. If the bail out and cause damage, use it, if they buy, return it to clear up your books and they can then apply it at settlement.

You can, since you're in a hurry, use a standard purchase contract, use a standard addendum and the delete or amend all contract provisions for default of buyer for failing to purchase and add that the sale is at the option of the buyer. That will get you to closing.

Down side, you may be limited by law as to a purchase agreement being valid over a year, you didn't mention the term.

Do not give any credits of any kind associated with any payment, I believe John credits settlement expenses as a seller's concession, which dances along the edge but is fine.

Reducing the sale price with any payment credit creates a financing agreement subject to Dodd Frank and SAFE Act provisions. Probably why your attorney said you don't want to go there, but you disregarded his subtle advice. So, believe me, you do not want to go there if you are not exempt, might ask your attorney. Explain that it is a straight option and not a rent to own (that term should be stricken from the minds of investors) use option to purchase instead.

The buyer needs to pay an option price. Easy way, non-refundable, if he only has say $1,000, then pay that for a 6 month option. Give him one extension of like term for another like option price. After a year write a new contract, you could reduce the sale price or keep it the same. That is as close as I'd get to financing an option price.

It would be much better if you went back to your attorney and cleared up the term you used and explain that you want an option to purchase, not a RTO (I can't even say the term).

Your buyer will be credited with the option price(s) he paid.

Doing any credit by payments creates a financing agreement, secondly, the buyer's lender will then have the appraiser set a fair market rent, a value set in the future that can be higher than when the rent was set. Regardless of what you agree to credit, the lender will only credit amounts paid in excess of FMR. What usually happens is that the lender doesn't count all the credits and the buyer is then required to come up with additional funds to bring the loan to it's correct loan to value amount, that is all they will lend on, but you can then adjust credits to what ever was agreed. If the borrower can't raise the additional money, usually can't on long contracts, the deal is dead. Then you have one really ticked off buyer. I won't go into what can happen, but you wouldn't like it and might be why your attorney said you don't want to do that.

Have you tenant get a tenant's policy, you carry the hazard policy.

   You may NOT transfer maintenance on a residential lease to a tenant. You may NOT transfer maintenance to an optionee under an option. You own it, maintenance is an owners responsibility in residential properties, primarily due to tax requirements, depreciation of repairs and improvements.

I knew I should have waited for Brian. what the heck, he can put up some links to take you around the world, (LOL) and throw in a nickel's worth. Guess I can always post again...LOL

You need to get back to your attorney and clear up the misunderstanding, what you call things in real estate matters a great deal sometimes, like here. :) 

Originally posted by @Kim Knox:

Your questions are too legally complex to answer from anyone but a lawyer.  I will offer a little insight. 

You need a state sales agreement, an option agreement, AND a rental agreement, tying them all together. It would be incomplete without all three.   You need concrete terms for the rental period, and the terms for the sales agreement, and the terms for the option.

I would charge a security deposit, much like a rental and give them the ability to credit the security deposit towards the purchase price when they exercise the option to purchase.  I would also change an earnest money, but you could elect to consider the security deposit the earnest money, just being very clear within the contract, the terms in which it would be refunded, or not refunded to the Buyer. 

I would also give them a due diligence period within the contract where they can have whatever inspections, appraisals, and title review BEFORE their occupancy date UNLESS you will not be particularly bothered if they do not exercise the option to purchase. 

YOU need to decide if you want to credit a % of the monthly payments toward the purchase price. A reason people may be interested in doing something like this is because that payment over a year, could minimize their down payment on the loan they select when they exercise the option. For example, if they are getting an FHA loan, their lender may be satisfied if they have paid 3.5% of the purchase price during the lease period. You could increase the purchase price, or just adjust the rental payments upwards with a larger % towards the purchase price.

The best thing in a lease option is to keep it simple, which is a total oxymoron because lease options are truly complicated AND high risk (for the Seller) in an increasing market.

Hi Kim!

You have some good points and some old school stuff mixed in, if you don't mind I'll comment....

First, the good, very good point of an inspection period and acceptance at the time of occupancy,  just like possession prior to closing. If deficiencies are noted later by the appraiser the repair will/could remain with the buyer.

A good option contains the terms of sale, so you don't need 3 contracts, unless the option is weak on that aspect. The lease terms may not be "tied" to performance under any other agreement, an option contract may not have any requirements for the optionee (buyer) to perform, otherwise while you may have an agreement you don't have a true option agreement.  

In an option, there is no earnest money as the buyer is not required to purchase, the consideration given is an option price. Up to 10% of the purchase price is customary. I already mentioned the security deposit and the reason for it, but I may not go there if I got 10% as an option price, depends on the buyer, the property, how I think they will perform.  

Manipulating the purchase price is a big no no. There will be an appraisal unless you have a cash buyer, it would be irrelevant if you did and they are rare in these cases. The lender will adjust the credits not only to FMR but also to excessive sale prices that are credited, this is "price puffing". Having a price at 3 or 4 % too high may not be a real blunder, depending on the price range, but if it is seen as padding for loan purposes you can be going down the mortgage fraud road. Just agree to a market value price and credit amounts paid on the option.

If you have a lease and an option and credits are excessive, you get into a disguised sale transaction under tax code. You also won't be evicting under a lease, you may need to foreclose.

Lastly, what a buyer or optionee is purchasing in any type of option contract, is the right to purchase at the market value agreed today, what they are buying with that option price is the market appreciation over the term of the option, that is the value of an option, it's not just a right to purchase as a buyer mat have in a purchase agreement. So, the term of the option should be somewhat sufficient to justify that value paid.

You're right, options are not simple. :)  

@John Jackson  @Bill Gulley  

A few questions that I may already know the answers to, but are worth asking anyway.  

John talks about using a "Tenant/Buyers Acknowledgement"...is this similar to the disclosure documents that Brian posts (the one's where I'm like "this looks good") which prompt Bill to summon fire from his fingertips?

John was adamant about not getting a deposit of any sort, while Bill suggests that you "should" get one.  I understand Bill's rationale, but John was forced to alter his train of thought to capitalize his message.  Why the disconnect here?

Bill comments on the semantics involved with the "rent credit" vs. "seller concession" and says that it "dances along the edge but is fine".  What is "the edge" and why is it ultimately deemed 'okay'?

Just so that I am clear on this.  Say OP wants a 5% option consideration.  A 'promising' T/B has 2 percent.  If OP creates a note for the remaining 3%, does this fall under D-F/SAFE/etc?

Bill, why the disdain for "rent-to-own"?  I have no horse in the race and use the 'proper' terminology, I'm just curious why that gets your hackles up.

Another thought. You cannot transfer maintenance of the property on to the T/B (which seems to be something a lot of 'teachers' either navigate around or just outright lie about). If you are doing L/O assignments, could you contract with a 'handyman' and offer that service to the seller free-of-charge (you could pay for this out of the assignment fee. Also keeping the "you don't have to be a landlord!!" thing kind of true)?

Thanks for the time gentlemen.

I'll hit this in the morning, except I'll mention part of the distain. RTO is specifically described in the SAFE Act which was incorporated into the Dodd Frank Act, it is one of the primary reasons these Acts nailed investors (scammers), these deals fail by intent or by design or out of ignorance of what must be accomplished at the end. It's the first federal law in finance matter that I have ever seen that mentions investor's strategies, they even put Lonnie Scruggs name in the Act/National Register painting him as a less than ethical guy! Never saw that before! So, yes, distain is a good description.

I'll say too, quickly, John's seller concessions as I understand them to costs is fine so long as they fit the loan program used, I believe he uses FHA and meets the guidelines. I have to assume, I never bought a place from him. :)

Good night all!   

@Jeremy T.   just to hit on a quick few items...the T/B ack is a CYA form that we use and it is in depth whereby the T/B states they understand all the terms, this is not a loan, and they understand they are responsible for getting prepared for finance etc. 

We don't ever take a deposit, because if the T/B moves out at the end of the lease and want's their "deposit" back, they think that means everything they put down. 

I don't want to muddle the waters. So..no deposit.  

As for the rent credit vs. seller concession, the rent credits are used towards the buyers closing costs. They can't go towards down payment. So, we don't even reference a rent credit in our docs. just a seller concession. Plus, lenders are very likely to request a rent rate appraisal if there is a rent credit in the contract. Just as @Bill Gulley   mentioned. 

I probably should backed up a bit more on deposits on the lease, you need to look at the big picture. In a forum, believe it or not, words typed are limited.

Need to underwrite the entire transaction, funds available, ability of the borrower/buyer/tenant to pay, price of home, perceived integrity, honesty and personality of your customer, their motivations. How strong is the deal? If it's rather weak, as most are with L/O deals (understand, if it was really strong, the buyer would just get a loan and be done with it) then, I lean toward the lease arrangement more than their thought of buying.

Yes, I could take a chunk down, non-refundable, keep the money and use that to make repairs, evict or defend issues that arise. I also want a fair amount down to motivate the buyer to buy. I'm limited to 10% practically speaking. It's also possible in longer term L/Os that I may have to foreclose, the short of that is you'll lose your 10% or most of it even if you win.

Any L/O done that ends up in court for one reason or another is going to be viewed under a microscope due to recent legal aspects adopted. Automatic suspicion toward anyone doing something outside the normal purchase.

I look very closely at predatory practices, in a residential deal I'm going to be seen as (and am) the expert in the room 99% of the time. I'll skip aspects of contracting from a superior position but that can be a liability in front of a judge.

I prefer negotiating first for possession under the lease, while we may have discussed buying, taking possession is first, then we reach an option at a price.

Much is the psychology of the sale too, the buyer wants in first.

So, how do I explain this to a judge (investors need to think in those terms in every deal they do, before they do it!). We agreed to a lease agreement first then we agreed to an option.

Having made a security deposit under the lease give evidence of thinking in terms of a lease first, a customary security deposit was made, did a lease and moved on.

If I don't charge on the lease side it can certainly appear that the lease was really more of an element of a sale, an installment sale or disguised sale or as the underlying motivation. While we may talk price prior to a lease, my presentation will take possession matters first, the lease is singed, dated with the time executed.

We know we are moving on to the option. What I then do is explain the option and I explain the end financing requirements. If they have credit issues or financing problems (and they will) I "teach" and "consult" as to what must be done. Two things here, 1. they get educated as to what needs to be done and 2. It takes time, so that when we do sign that option contract, the time "stamp" is later than the lease. This helps to show that the two contracts are separate and distinct. One was done, then the other. I've done many options days and months after the lease, one reason is often allowing folks to save more money.

IMO, if I don't take a security deposit and do what is customary in making a lease, the two contracts merge in concept leaning toward a sale transaction. If it appears that I just took a larger non-refundable option price, the "flavor" changes, my argument of separate and distinct is much weaker.

I'm also standing on more solid ground if I have to get a tenant out under a lease alone. A few were removed allowing the option to stand, another subject but I never had an issue with an outstanding option, they expire and it doesn't prevent me from leasing or selling as most investor believe. An option does not tie up a property to the extent that an owner can't proceed with other dealings.

Most residential L/O deals are weak. I also have bigger issues with predatory dealing if I take a big option price, the perception of a sale, keeping the contracts at arm's length help defend any of those issues as well.

Have I ever done a L/O with just an option price, sure, as the buyer it's obvious, I've done it from the seller's seat as well, when I have a more sophisticated buyer, good income, stable, has the ability to pay where the deal is not stretched out for 3 or even more years.

Using L/Os is a method of getting you to a sale, that is the ultimate goal, the security deposit is irrelevant as you move to meet that goal. A L/O is not a method of making money under some rinse and repeat idea that is predatory dealing. You don't do L/Os to any zombie that can fog a mirror! Each deal must stand on its own merits, appearance matters and is a reflection on your integrity and fair dealing.

My approach may have something to do with never losing money in a L/O deal or losing any law suit, I've had sabers rattled at me before, but never lost......knock on wood!

This is long, I'll address other aspects later.

Where did Brian go?   

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Wow... this blew up. I'm still reading through it all but from what I gathered so far I have this.

I need basically need 3 forms...

The lease

The lease option

and a T/B acknowledge document. ( just needed to CMA)

The lease I have written up like a standard lease

The lease option I need that will basically detail the agreement. 

1. I won't sell to anyone else during the lease option

2. How much we agreed I will sell it for

3. How much they will pay for the lease option

4. The lease option payment is non-refundable

5. How long they have to exercise their lease option

6. How long they have after they exercise their option to find financing for the property.

Then I need the Tenant/Buyer acknowledgement to cover my A... saying that they were not under duress and fully understand the documents they signed.

Do I have it just about covered? Does anyone have links to a sample LO that I could fix up and a T/B acknowledge document. I will look for them but if someone has the direct links to take me there it would be appreciated. I don't want to risk grabbing the wrong document.

Thanks @Bill Gulley   especially for your informative posts. As well as everyone else who has helped me. It's much appreciated. 

Also I won't add a rental credit. I will just ask for the straight up lease option fee. And I will not word them as a deposit, and make it clear that the Lease option is non-refundable.

Jason,

You need 2 agreements:

1. Lease; and

2. OPTION to Purchase

Not "Lease" and "Lease Option".

The Lease Agreement gives your tenant the right to occupy the property. The Option Agreement gives your buyer the right to buy the property and it obligates you to sell at an agreed upon price.

As always though, even though there are templates out there, consult a real estate attorney in your state. There could state-specific rules you need to consider.

There was a form on here the other day, some CYA acknowledgement form.

Please don't use that kind of junk, no attorney wrote that thing, it duplicates contracts covenants, it asked questions or for information far beyond contracting assumptions, like I'm not under the influence, really stupid stuff. It makes you look like you're scared to death to contract as a prudent, normal person, so much so it draws attention to the fact that you're trying to lock someone in so tight as blocking any claims it shows you're going to extremes in contracting. At that point, Lord only knows what was said in the pitch.

Any time you get past what is usual and customary you're tagging yourself as someone who doesn't deal in an accepted manner, you have to be different, now why is that? Shows a lack of business law and remedies. Most of you think if a guy is drunk he can't contract, not true! Then you put that in your CYA form. Judge looks at it and says "ah, guy is using total BS crap trying to cover his tracks".

I think that stuff has more to do with the marketing side of someone selling their programs, showing they have you covered from all angles and what they provide is bullet proof. Nothing is bullet proof in contracts, there are many other aspects that show the relationship between the parties, the conduct of the parties, their sophistication and fair dealing  is far more important than making someone declare what they are doing is a great deal for them.

If I were an attorney and my client had been given junk like that to sign, not only would I tear it up, I'd use it to paint a picture of the one who required it and rip them a good one. 

Take your stuff to an attorney before you use it, don't get junk from jailhouse lawyers trying to manipulate things with slick talk. All you need is a good contract, leave it at that. :)

Everyone does it differently. Heck I didn't it differently for many years.

I have done over 100 RTO deals.

I have learned over the years that the simpler the better. I had many lengthy option agreements and various other agreements. I dumped all that. I now use only 2 documents.

1. An agreement of purchase and sale that closes in x years. The deposit and defined here.

2. A lease agreement for the duration of the deal.

And tie the 2 together. 

Note: There may be some limitations in some areas but I'm pretty sure this work work in most areas since I use a standard real estate form and a standard lease agreement.

Oh, and a little word of advice ... don't believe someone when they tell you that you can't use certain contracts. Check with a lawyer.

That's it.

@Stephanie Cabral

Why would you? If a tenant made an improvement, which is another big no no, why would you reduce the sale price, value of the property, from your sale to reflecting the value of that improvement?

Don't you just love public forums, I know I do, you'll always get the old experts jump in who are asleep at the switch saying how they did some strategy tons of times years ago. there is probably a book about Dodd-Frank on BP (not all good info, BTW) and we still get the Lonnie Deal types rolling in. 

We also have the inexperienced who can't define an installment contract who attempt to contradict others who can, attempting to apply logic to financing regulations or regulatory matters in order to push their marketing agenda of ill conceived ideas. Laws are not always logical, especially at first glance. 

Tenants doing repairs or improvements in residential effects IRS requirements, depreciating part of a property as you are required to do means, if you didn't pay for it, you have false claims on your taxes if you did declare it and false returns if you don't adjust it and no residential tenant can deduct such costs, commercial tenants can.

Again, Rent-To-Own is described in Dodd-Frank, it is a dead strategy as it has been done in the past. John Jackson and Brian Gibbons are well aware of the issue and they are not newbies, things have changed. Be careful who you listen to on the internet. :)    

I would not do that without a realtor or a real estate lawyer. Are you collecting a lump sum of money upfront? I would not do that on your own especially if you don't even know what forms to print out. I am not being ugly, I am just being real.  

@Bill Gulley

I got into this late...

@John Jackson

Nice posts as always

I like a lease and a ROFR right of first refusal and working with the tenant and a mortgage originator in some states like tx and nc 

I find it interesting that many experienced agents and brokers are still behind the eight ball regarding Dodd Frank and Safe Act

And I wish there would be an opinion letter from the CFPB regarding lease options

@Hattie Dizmond

@Guy Gimenez

@Brian Gibbons

The lease-option is mentioned and it's pretty clear, if it's a "financing agreement" then you have to look that up, which is basically anything that can be devised by man or beast under the sun within the jurisdiction of Federal Law that reduces an agreed sale price by periodic payments and that is secured by the property sold or may cause title not to be passed in the event of failure of making such payments. Paraphrased for the layperson with emphasis added :)

Crediting rents to the sale price from a required payment (rents) reducing the agreed sale price constitutes a financing agreement, since non-payment of rents will cause a default and title will no longer pass. 

Going around the bush the long way, finance the option price that is credited to the sale price, failure to pay the option price effects the agreement to pass title. 

A contract for deed has required payments credited to the sale price and so long as payments are made, title is to  pass as agreed. 

Another way to look at it is that if you hold the title hostage in any way, that is a security arrangement or security agreement in that property sold. 

Want to avoid Dodd-Frank, sell a house and grant title for the note on an unsecured basis or take the buyer's new $165,000 Porsche as collateral on the note selling the $80,000 house. That might work as there is no security arrangement involved with the property sold. 

Another way, if you are single, marry the buyer, when they perform, agree to a divorce, simply because transactions between closely related family members are generally exempt from finance laws. The flaw in that is that if they fail to perform and divorce you, they may well end up with the house anyway!

Just trying to feed that creative spirit of yours Brian. LOL  :)