Different variations of lease-to-own: Alternative to a mortgage?

You dream of your own four walls, but you lack the equity required for favorable financing? Further information: Real Estate without Equity. In the following article, we present you with an alternative to the classic purchase of real estate. You will learn everything you need to know about lease-to-own, how this model works, and what advantages and disadvantages it entails.

Why is lease-to-own an alternative to a real estate loan?

To apply for real estate financing, you usually need to contribute 10 to 20 percent of the purchase price as equity. Conditions and tips can be found in our guide to Mortgage Comparison. For the bank, existing equity reduces the risk, in addition, additional costs are not financed and must be paid separately by you. Of course, there are also institutions that fully finance real estate. However, interest rates and requirements for full financing are significantly higher.

Simple and easy-to-understand principle

When purchasing through a lease-to-own agreement, you enter into a rental agreement with the owner. This agreement specifies that the rented property will transfer into your ownership at a certain point in time. Furthermore, the agreed purchase price for the house or apartment is set in writing. The rent includes a precisely defined savings amount for the future purchase. With a lease-to-own agreement, you move into the property as a tenant and become the owner through the savings amount. When purchasing the property, only the saved amount is accounted for against the price, and a portion of the monthly payment is retained by the previous owner as rent.

Lease-to-own – two models to choose from

With this approach, you can choose between one of the two models described below:

Lease-to-own in classic form

With this model, you jointly determine with the current owner under which conditions the property will transfer to your ownership at what time. The purchase price is deferred to you including interest, and you repay your debt with monthly payments. Either the monthly installments are set so high that you become the owner after a certain period without any remaining payment. Or you pay off the remaining debt with a loan after a rental phase. The saved amount could serve as collateral (equity) for the financing bank.

The Cooperative Model

When it comes to houses and apartments in cooperative ownership, the option to purchase is often used. You enter into a lease agreement that includes an option to buy the residential property. In the event of a purchase, the cooperative deducts a portion of the paid rent from the purchase price. The price is set when the lease agreement is concluded and remains unchanged. You can refuse to buy after the end of the lease, as you do not incur any obligation to purchase. It is also worth noting that in the classic version of a lease-to-own arrangement, a down payment of 20 percent of the purchase price is often required from you. If you are unable to pay this amount, the down payment is added to your rent in installments, leading to a significantly higher monthly burden. Since you enter into a binding contract with the owner in the classic lease-to-own model, you must have the remaining purchase amount available at the agreed time. A one-time closing fee is always due when a lease-to-own agreement is made.

Option to Purchase

When purchasing an option, there is no binding contract, however, your option right must be noted in the land register. This secures your right to purchase within the agreed time frame. This security, however, results in comparatively high rents that include both principal and interest. The cooperatives bind their tenants to the purchase through the high monthly payments. Only a few cooperative providers allow cancellations and return the savings payments.

Rent-to-buy always with notarial certification

Similar to the classical purchase of real estate, the execution of a lease-to-own agreement must also be handled by a notary. The effort is even greater, as two contracts need to be created. In addition to the lease agreement, a contract for the purchase of the real estate must be drawn up, and both documents should be notarized by the notary. Without notarization, any lease-to-own contract is invalid. In the case of an option to purchase, the notary must be commissioned to make an entry in the land register. This right of first refusal expires automatically upon termination of the lease agreement; otherwise, it remains valid until the predetermined acquisition date. Note: Regardless of the preferred option, you should consult an independent real estate expert before making a lease-to-own decision. Unfortunately, there are always unscrupulous actors in the industry who want to get rid of their hard-to-sell properties through supposedly attractive lease-to-own offers. Before signing the contract, consultations regarding possible payment difficulties of both parties should take place at the notary, and appropriate provisions should be agreed upon.

Advantages and Disadvantages of Lease-to-Own

With both models, there are advantages and disadvantages for both the owner and the tenant (future owner). The following aspects appear advantageous:

• The credit offered by the seller provides easy access to homeownership, although the rent is significantly higher than with conventional rental properties
• Since a loan is rarely required at the time of purchase, banks are not involved in lease-to-own arrangements
• Economically, the property immediately becomes the tenant’s property because he contributes savings shares through his rent payments
• The agreed installments are independent of interest rate developments and remain the same throughout the entire period
• The option purchase model allows the tenant to live in the house or apartment for a while and then decide for or against a purchase
• The landlord is not bound by the local rent index, he can demand higher rents and does not have to make refunds in case of contract cancellation

As with any economic transaction, there is also a disadvantage to renting to buy alongside the positive side. The other side of the coin looks like this:

• In the end, as a tenant, you pay significantly more than you would if you purchased the property directly
• Compared to a conventional mortgage, the terms are usually worse. The rent is significantly higher than the local market rent, and additional fees and costs apply
• You will certainly be required to have an above-average and secure income in order to cover high rents and savings contributions
• Your payments are usually lost in the event of the seller’s insolvency, and the planned purchase cannot be completed
• The financial support available for a conventional property purchase is not available for a rent-to-buy arrangement
• Although you are partially responsible for repairs and modernizations during the rental phase, you often lose the right to have a say in larger construction projects
• Experts recommend a repayment share of at least 80 percent for a rent-to-buy arrangement, based on the monthly payment

Conclusion: Rent-to-own as an Alternative to a Loan

Rent-to-own is often an impulsive choice for financing one’s own home. With the high income required, full financing through the bank becomes possible and seems sensible. The slightly higher interest rates of a financing option without equity are offset, especially for young families, by state subsidies and grants. You should seek competent advice before deciding on a rent-to-own agreement and consider the classic path to property financing.