Buyers looking to take control of a property without going through traditional financing typically have two options. They can lease the property with an option to buy it, sometimes called a rent-to-own or a lease option arrangement. Or they can buy it, one small piece at a time, from the seller through a land contract, contract for deed or installment sale arrangement. While the two arrangements may feel similar from both party's perspectives, the underlying structures are completely different.
Sale vs. Rental
The different natures of the two transactions start when the owner and buyer, or landlord and tenant, meet. Since a rent-to-own transaction is a rental with an added bonus, many tenants come in through traditional rental tenant avenues like property managers, yard signs or classified advertising. Since a land contract is essentially a sale of the property, buyers frequently come through real estate agents unless the owner chooses to list the property herself as a "for sale by owner." This can make finding an buyer through a land contract more expensive for the owner than finding a rent-to-own tenant.
The different nature of the two transactions also extends to taxation. Under a land contract, the buyer can write off the interest he pays on his land contract as mortgage interest while the seller of the property reports the interest payments she receives as income. In a rent-to-own situation, the buyer is legally a tenant and cannot write off his payments. The owner gets to treat the property as an investment, which means that she has to report her rental income on her tax return but gets to deduct all of her expenses from it.
The seller retains a degree of control over the property under either scenario. With a lease option, it's easy for the seller to craft terms that will invalidate the buyer's right to purchase the property. On the other hand, since the buyer is a tenant, he will enjoy the same protections as any other tenant under the laws of the state in which the property is located. Land contracts give most of the rights of ownership to the buyer so the seller has less ability to control the property, but she also gives up the responsibility of being a landlord. However, if the buyer fails to make his payments, the seller can usually cancel or foreclose on the contract. The seller also gets to keep the money that the buyer paid her over the life of the rent-to-own arrangement or the land contract.
Buyers in either instance have fewer rights than they would under a traditional mortgage, since the seller may be able to take the property back more easily. However, buyers have one key benefit under these two arrangements -- they don't own the property. If they need to move, if the house needs significant work, or if anything else changes, they can choose to walk away from the contract or option. They'll lose the money that they've put into the house through their payments, but they won't be stuck owning an unsuitable property.
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- John T. Reed: What You Need to Know About Lease Options
- Foreclosure University: Lease Option - Lease With Option To Purchase
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