What is a Lease Purchase?

A lease purchase is an agreement between the tenant and the landlord which allows the tenant to purchase the rented property from the landlord once the lease period expires. With a lease purchase agreement, the tenant enjoys exclusive rights to purchase the property at a pre-determined price.

How does a lease purchase work?

A lease purchase comprises two separate contracts:

• A residential lease, which allows the tenant to rent the property for a specified duration; and
• A contract for sale, which obligates the landlord to sell the property to the tenant upon expiration of the specified lease term.

Usually, the lease purchase will also have cross-default provisions, which means that a breach in one of the contracts (for example, tenant misses his monthly rent payments) will render the same for the other contract.

With a lease purchase contract, the rent charged on the property is usually higher compared to the market rate. The premium that is paid on the rent contributes to the down payment when the tenant buys the property at the end of his lease. In addition, the tenant may have to provide for repair and maintenance costs, property taxes and insurance on the property, something that the landlord is usually responsible for.

The purchase price of the property in lease purchases is usually fixed at the market value of the property upon commencement of the contract. This generates potential savings for the buyer, as he is purchasing the property at a relatively lower price, especially if the property’s value increases over time.

Read also: What is Market Value?

Lease option versus lease purchase

A lease purchase and a lease option are quite similar as both of them are fundamentally rent-to-own agreements. The key difference between them is that a lease option only obligates the landlord to sell to the tenant, while providing the option for the tenant to purchase the property if he wishes to. However, for the lease purchase, both parties are contractually obliged to engage in the transaction of the property.

Read also: What is Tenancy in Common?

Benefits of lease purchases

From a tenant/buyer’s perspective

As a buyer, lease purchases provide a tactical option which helps you purchase a property, especially if you require more time to accumulate savings or to build up your credit score. Renting the property first enables you to prioritise accumulating additional savings and simultaneously improve your credit score by continuing to consistently meet your rental obligations. Furthermore, the premium that is paid on the rent also contributes to the downpayment on the home, facilitating the overall home buying process.

From a landlord/seller’s perspective

As a seller, lease purchases are a strategic way to attract potential buyers as it provides buyers with little savings or a poor credit score an alternative to purchase a property. Since lease purchases usually require the tenant to pay for maintenance fees and purchase the property at the end of the lease, tenants who are interested in the property are usually more responsible tenants who will maintain the property well. Furthermore, the premiums on top of the rent provide an additional income for you.

Tradeoffs of lease purchases

From a tenant/buyer’s perspective

Extra payments
You have to pay extra monthly payments on top of the usual rent for the lease purchase, as the premium goes towards the downpayment for the property. However, you must be able to afford the extra payments or risk termination of your lease. You also have to cater for the property’s maintenance fees, taxes and insurance, and hence should factor in these additional costs when budgeting.

Risk of breaching contract
Both parties must follow through with the transaction of the property. However, as a buyer, you must have the financial means to be able to purchase the home in the first place. If you are unable to qualify for a loan for reasons such as having a low credit score, you will not be able to purchase the property. As such, you may end up breaching the contract, and stand to forfeit all the premiums paid on the rent along with other miscellaneous fees that you would have paid to the seller.

From a landlord/seller’s perspective

Potential loss of earnings
The purchase price is determined when the agreement is signed. This purchase price is fixed and cannot be changed. If the value of the property increases over the years, you are still obligated to sell the property to the tenant at the fixed price that was previously agreed upon.

The Bottom Line

As buyers, lease purchase agreements allow you to purchase a property even if you may not have the financial ability to do so today. However, you must be confident that you would be financially able to purchase the property after the lease expires.

As sellers, lease purchase agreements are a favourable alternative for you to attract buyers without the potential hassle of listing the property on the market and engaging in lengthy negotiations with prospective buyers.

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Disclaimer: The information and/or documents contained in this article does not constitute financial advice and is meant for educational purposes. Please consult your financial advisor, accountant, and/or attorney before proceeding with any financial/real estate investments.