Lease-to-own arrangements, sometimes also called lease purchase agreements, don't have to use escrow accounts. However, given the large sums of money that are changing hands and the potential complexity of lease-purchase agreements when renting to own real estate, escrow accounts can be a wise addition to a lease-to-own purchase. They can be easy to set up and inexpensive to maintain, especially when compared to the amount of money that changes hands in a lease-purchase agreement.
In a typical lease-to-own transaction, the tenant pays extra money at the commencement of the lease and every month thereafter. The initial extra payment, called an option fee, gets applied to the eventual purchase price of the house. In addition, every month's rent payment contains an extra amount that gets applied to the purchase price. At the end of the option, the tenant can amass thousands of dollars that get applied to the purchase price of the house, helping to make it more affordable to buy.
Escrow accounts are set up by third parties to hold money. In a lease-to-own structure, the tenant pays his money to the escrow account, and the escrow holder pays out the security deposits, fees and rent to the landlord. The tenant's option fee and monthly extra payment stay in the escrow account until they need to be disbursed.
Escrow for Tenant Protection
An escrow account protects the tenant, who can be assured that the extra money paid toward the house is going to be there when he's ready to exercise the option to buy. Since a lease-option is effectively a forced savings plan, it makes sense that the escrow account is an actual savings account. A wary tenant can require that the escrow account holder pay the landlord's mortgage and property taxes. If the escrow pays the mortgage and taxes and forwards the difference between the mortgage and tax payments and the rent payment to the owner, the tenant gets an extra level of assurance that the property is not going to be foreclosed on and wipe out the value of his option to buy.
Escrow for Landlord Protection
For landlords, an escrow account may seem like more of a hassle, but it can solve two important problems. First, it eliminates the need and the responsibility to keep accurate records on the tenant's credit balance. The escrow account balance simply becomes the tenant's credit balance, and the landlord doesn't have to worry about the escrow money ending up commingled with other bank accounts. It can also automate the process of owning the property; if the escrow account accepts rent checks, sends mortgage and tax payments and forwards the landlord her profits, it saves time and effort on the part of the landlord.
Steve Lander has been a writer since 1996, with experience in the fields of financial services, real estate and technology. His work has appeared in trade publications such as the "Minnesota Real Estate Journal" and "Minnesota Multi-Housing Association Advocate." Lander holds a Bachelor of Arts in political science from Columbia University.