Difference Between Contract Sale & Rent-to-Own of a House

A contract sale of real estate involves making periodic payments to the owner in order to buy the property.

A contract sale of real estate involves making periodic payments to the owner in order to buy the property.

Many people buy houses through a traditional mortgage loan. However, that's not the only way to purchase a home without coming up with the entire purchase price. In some cases, you can buy a home "on contract," meaning by arrangement with the seller. You can also sometimes enter into a rent-to-own agreement to buy a house, which means you will rent the house for a period of time, then have the option to buy it.

Tip

A contract sale of real estate involves making periodic payments to the owner in order to buy the property. In a rent-to-own deal, you will lease the property for a period of time, then have the option to buy it.

Understanding a Land Contract

When you buy a house on contract, you're typically getting financing from the seller to buy the property. This is different from a traditional mortgage loan, where you get financing from a third party financial institution, such as a bank or a credit union, to buy the property, and the rules are slightly different.

As with a mortgage loan, you will be required under the terms of the contract for sale of real estate to make regular payments that will ultimately pay the cost of the property plus some interest. The payments you need to make and when you need to pay them will be spelled out in the contract, just as they would in a promissory note or other document related to a mortgage loan.

While you are making the payments, you will usually be able to live in the house and otherwise use the property as your own. Legally, title remains with the seller until the contract is paid off, at which point both sides will ensure documents are filed with the appropriate land records office to legally transfer title to the buyer. Work with a real estate lawyer if you're not sure how to do this in your jurisdiction.

If You Have Trouble Paying

An important difference between buying a house on contract and getting a mortgage is that if you fail to make payments on a land contract sale, you often have fewer rights than you would with a traditional mortgage loan. Specifically, the seller can often take you to court and get a judge to order you to forfeit the property and all the money that you have paid toward it.

This is different from a mortgage, where if you fail to pay, the lender can usually seize or auction off the property through the foreclosure process, but you won't lose the equity you've already built up in the home through your payments.

Land contracts are sometimes easier to get than traditional mortgages, but remember that they can be riskier if you aren't totally sure you'll be able to make the payments on time. No matter what options seem to be available at first blush, it's a good idea to compare your different options when buying a home to see which will bring the best interest rates and protect your rights. Consult a real estate broker, mortgage broker or other professional for help if you need it.

Renting to Own a House

A rent-to-own agreement works slightly differently than buying a house on contract. Generally you will have a traditional real estate lease, just as you would normally have when renting a home, along with an agreement giving you the option to buy the home at a certain point. If you can come up with the money at that point, the owner must sell you the house at the agreed-upon price. However, in some circumstances, you may actually be obligated to buy the house at a particular time and price.

In exchange for having the option to buy the house at a particular time and price, you'll pay a slight premium above what you would ordinarily pay to lease the house. Depending on your agreement, some of that payment may be credited toward a future down payment on the house, which is somewhat similar to buying a house on contract.

Financing a Rent-to-Own Purchase

If you don't buy the house while your option is available, you will usually forfeit that money. While it's possible that the seller could offer to sell you the house on contract, you'll typically be expected to secure your own financing to make the purchase, such as through a mortgage lender.

Using a rent-to-own agreement can be advantageous if you know you want to buy the property in the future but don't have the funds immediately to do so. But it can backfire if you don't come up with the money in time to exercise your option to buy. That's because the premium above the normal rental price that you will have already paid will be forfeited.

Paying a Rent-to-Own Penalty

If you signed an agreement where you have an obligation to buy, you may even owe a penalty if you don't do so at the specified time. Make sure you review any lease with a rent-to-own option carefully, working with a lawyer if necessary, so you don't encounter any surprises. Consider how likely you are to actually buy the property and how attached you are to it.

You may in some circumstances be better off taking a standard lease and either making an offer to buy the house when you're ready to do so or simply buying another property when you have the necessary funds and credit.

Getting the Paperwork Filed

If you buy a house through either a rent-to-own agreement or on contract, it is important that you make sure all the paperwork is legally valid in your jurisdiction and that it's filed in the appropriate office. Usually this will be a county, town or city land records office. There may be a fee to file deeds and other relevant documents.

If you have any questions, don't hesitate to contact a lawyer. You may also wish to contact a title company to ensure the seller has the rights to the property. If you believe you own the property but there is any kind of issue with the ownership before or after you buy, you may be in for trouble at some point in the future, including when you or your heirs look to sell the property.

Other Rent-to-Own Agreements

Houses aren't the only items you can buy on a rent-to-own basis. Automobile leases often contain provisions letting you buy a car after you've leased it for a certain amount of time. You can also use rent-to-own agreements when buying household items like furniture or appliances.

These sometimes work similarly to buying a house on contract, in that after you make a certain number of payments, the item is yours. But if you fail to make required payments, all the money you have put up is lost.

If you're considering any kind of rent-to-own agreement, evaluate the total cost relative to simply renting the item or financing it through some other means, like an auto loan or a credit card. Rent-to-own purchases can be more expensive, so you may want to consider alternative methods if they're available to you in your financial situation.

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About the Author

Steven Melendez is an independent journalist with a background in technology and business. He has written for a variety of business publications including Fast Company, the Wall Street Journal, Innovation Leader and Ad Age. He was awarded the Knight Foundation scholarship to Northwestern University's Medill School of Journalism.