What is a Texas Lease to Own Contract?
Lease to Own contracts, commonly known as rent-to-own contracts, are actually defined by Texas Property Code section 92.021 and a detailed Statutory Disclosure (Tx Property Code sections 92.061-069). A lease to own contract is a rental agreement that also contains the option to purchase the property. The Statutory Disclosure contains all of the additional disclosures that are required for this type of contract.
The Property Code defines a lease-to-own contract as "a contract under which the owner agrees to transfer ownership of a dwelling to the occupant in exchange for consideration and under which the occupant is not required to execute a mortgage, deed of trust, or other security device on the dwelling . " There are, however, restrictions in other parts of the statute that limit how the payments can be allocated to rent and to the proposed purchase price of the property. The goal behind these types of contracts is generally to allow the tenant to take possession of the property before they are in a position to actually purchase the property and to allow the tenant to ‘rent-to-own’ over time before the purchase is made.
Essential Terms of a Texas Lease to Own Contract
Lease to own contracts in Texas are very different from those in many other states. While in most states that allow lease-to-own contracts, the buyer makes periodic payments like a typical lease, those payments are partially principal and interest, and partially rent. At the end of the lease period, the buyer either has the option of buying the property or the lease automatically converts to a mortgage. In Texas, it is not permitted to partially apply payments to principal and interest and thus effectively convert to a mortgage. All amounts paid under a Texas lease to own are applied only to rent for the property. A Texas lease to own also cannot convert automatically to a mortgage. Rather, if the buyer opts to buy the property, the parties must execute a new mortgage at that time. Texas law requires the mortgage include numerous provisions related to payment schedules, right to accelerate, warranty of title and various disclosures, which must be contemporaneously signed by the purchaser.
Perhaps the most significant distinction between a lease-to-own and a lease with an option to purchase is in the use of the property. The optionee is typically permitted to occupy the property and is responsible for taxes and maintenance, which may resemble the situation in a typical lease. However, the lease to own gives the lessee the rights of ownership, such as the right to transfer the property without the consent of the lessor, to encumber the property and even to use the property for commercial purposes.
A Texas lease to own is further distinguishable from a simple lease in that it contemplates the opting-to-purchase of the property. A residential lease, for example, often requires the tenant to give 60 days’ notice to terminate the lease and the tenant is sometimes subject to a penalty equal to the price of one month’s rent if they vacate the property before the end of the lease term. If the tenant decides to simply vacate the property and not purchase it, the landlord may elect to double the amount of one month’s rent in addition to the base price of one month’s rent and deduct that amount from the security deposit as the actual damages. On the other hand, a lease to own usually allows the tenant to vacate the property and demands only the base price of one month’s rent to reimburse the landlord for the damages. This is called a base penalty.
A Texas lease to own also frequently includes covenants requiring the tenant to insure the property and to pay all taxes related to it, including sales taxes, property taxes and school and municipal taxes. A Texas lease to own should expressly provide that the lessor is permitted to re-enter the property and take possession of it without going through a formal eviction process.
Advantages for Buyers of Texas Lease to Own Contracts
Lease to own opportunities in Texas often come with more flexible purchase options than traditional sales and are increasingly popular with potential buyers. In many cases, the agreements allow home-buyers to ‘test’ home ownership. There are also options to buy at a predetermined time or after a specified period of time at a price agreed to in advance.
For those with less than stellar credit or a less-than-prime financial history, lease to own contracts offer several benefits. Buyers can move quickly into a home, similar to renting, but earn equity in the home they choose for a later purchase. If home values in that area increase or if the buyer’s financial situation worsens, the buyer knows he or she has the right to move out and terminate the lease without fear of losing the amount of money already paid.
Advantages for Sellers of Texas Lease to Own Contracts
A lease to own buyer has a strong incentive to look after your home, so sellers of homes have the benefit of peace of mind of knowing that tenants are taking care of their property. Because buyers are looking for a permanent place to live, sellers often see a lot of pride and commitment toward the home that is notably different from traditional rental agreements. Likewise, because the buyer is making improvements, you also have a buyer who is angling for your best possible price.
Lease to own rental agreements can also be a strong way of earning a steady income. The down payment made by the potential buyers often covers a year of rent. In addition to that, your mortgage is being paid out of the rental agreement as well as any repairs the tenants might make. Once you receive lump sums for things like taxes or special assessments, selling your home will not come with the burden of being behind on the bills.
Long term tenants also mean long term profits. Your lease arrangement can last as little as 1 year but as long as 3 years, allowing you a consistent stream of income without the hassle of re-renting your home.
Downsides of Texas Lease to Own Contracts
Both parties must be careful of the potential pitfalls involved in a lease to own contract. If a tenant is late in making a rent payment or if a landlord provides one too many late rent notices, the disagreement can easily devolve into protracted litigation over what rights the parties have under the agreement.
Vague or incomplete terms can cause problems for both the lessee and the lessor. A poorly worded lease can make it impossible to complete the purchase, leaving the lessee out on the street. A poorly-drafted lease could lead to a dispute over what the landlord is even allowed to do with the property. When entering into the purchase, if the parties don’t have a clear understanding of the right of first refusal, they could cause future litigation over whether the option was properly exercised. And while the jury may still be out on whether a lease to own contract can include provisions meant to protect the owner – such as unreasonably high repair costs and potential add-ons if the lessee misses a payment – the savvy lessee should avoid entering into a contract with these restrictions.
Contingencies and Legal Protections
A third area to understand when buying a house "Lease to Own" is the legal protections and contingencies built into the contract for both sides. Most Lease to Own contracts contain language outlining if the buyer can’t make a payment, default, or just walks away from the property. The contracts also have language about if a buyer does the right things and pays as agreed. When the home buyer starts missing payments, how long does it take to evict them? Does the seller have to go through a normal eviction process , or does the contract somehow speed it up? Is the seller on the hook if the buyer damages the property and there is no insurance? Is the buyer on the hook for the mortgage payment if they are late on payment? Is the seller on the hook for the whole mortgage even though only 1 person may have lived in the property? These are all important questions and why a Lawyer should be consulted to read the Lease to Own contract being signed.
How to Draft a Texas Lease to Own Contract
Before you can draft a Texas lease to own agreement there are a number of steps that should be followed. First, you should conduct a title search on the property. This is the most important step as you do not want to give a buyer an option to purchase your home until you know clear title exists. Any deed restrictions or other restrictions will need to be disclosed and included in the contract. Next, you should confirm the buyer is qualified to purchase your property. While it isn’t necessary to check the buyer’s credit, it is a good idea to make sure the buyer intends to purchase the property as outlined in the lease option. An option is a unilateral right to purchase property in the future. In other words, there is no mutuality contained in the contract. However, the Texas Deceptive Trade Practices Act and Texas Business and Commerce Code impose a duty of good faith and fair dealing to the relationship. You need to make sure that the buyer intends to follow through on the agreement.
Once you have confirmed title and verified that the buyer intends to purchase the property you can begin to draft the necessary Texas lease to own agreement. It should be noted that any Texas home sale over $50,000 needs to be in writing. Once the agreement is drafted, the buyer must execute the lease to own contract. Once the agreement is signed you will be required to file the appropriate document to make the sale part of the public record. In Texas this usually requires a deed and a deed of trust. The intervening mortgage will impose the buyer’s obligations as part of the chain of title. These additional documents will put third parties on notice of the sale.
Common Mistakes in Texas Lease to Own Contracts
A common pitfall in lease to own contracts arises from the contractual terms not matching the parties’ understanding, often resulting from disagreements on the nature of improvements made to the property as well as the calculation of rent credits. Accurate record keeping is essential if the buyer makes any improvements to the property whether it is to bring a building up to code or to construct a new structure on raw land. Documentation of equitable title is also critical. Without such documentation, the seller may prove more successful in title litigation than the buyer is in claim litigation against the seller. Another potential problem can result from assuming that the terms of a lease option are seamlessly translatable into a lease purchase agreement. For example, an option to purchase may not be enforceable in a sales contract. Conversely, a lease purchase agreement does not offer the buyer the option to purchase. The buyer needs to understand when the option is binding and when it is not. The final potential problem arises from misunderstanding the amount of the monthly rent. Without specificity in a lease option agreement, a landlord may erroneously charge late fees on delinquent rent without the parties attaching a dollar amount to those words. While it appears straightforward enough to agree on a rental amount, the parties have to agree on how overdue rent will be accounted for if the payments are not received in full at the end of the month.
Texas Lease to Own Contracts: Real-Life Examples
Let’s drill down into the real life side of lease to own contracts with some examples taken from the files. I recently settled a case in the McKinney area that involved a lease to own. The Plaintiff was a family, the landlord was a real estate investment company that marketed their property as a "rent to own", with no up front cost and no credit check. The family signed the lease, paid a security deposit, and were presented with the lease to own contract by the landlord. The Plaintiffs in this case had a number of problems with the property, including a leaking ceiling from water damage, crumbling walls and broken appliances, among other problems. They notified the landlord repeatedly in writing about these issues but he never responded, even while the Plaintiffs continued to pay the rent. This went on for almost 3 years before they called me. The first step was to clear up what type of issue we were dealing with. The first step was a free consultation to determine whether the issues being complained about were considered a "major repair" under Texas Law. It is very important to talk to someone who knows the laws in Texas when dealing with repair and lease disputes. We identified that the issues were major repairs as defined by the Texas Property Code and began taking action. The process involves sending the landlord a demand for repairs, and following the strict requirements set out in the Texas Property Code in order to allow the tenants to withhold the rent legally. Once that was filed, we had our landlord send an independent third party out to inspect the property. This took a couple of attempts because we wanted to make sure the expert instructed to inspect the property was truly independent. Once the inspection was done we filed a lawsuit . We were able to settle it and get an amount of money awarded to our client which will more than make up for the lease payments the family made, any repairs needed in order to move into a new property and put money in the family’s pocket for their trouble. A different circumstance, same result. The family was seeking an affordable rent to own opportunity in Dallas County and found a perfect house in the winter of 2015. They paid the landlord a large sum of money as a "Non-Refundable Option Payment" due at the time of lease signing. However, a couple of months after they moved into the house, the plaintiffs discovered they had been locked into a bind. The lease to own agreement was written in such a way that it favored the seller, as all "rent to own" agreements do. But it also avoided telling the tenant exactly what needs to be repaired and what doesn’t. The sellers did not repair anything. The heater was broken, the roof leaked, toilets ran, water was not getting to the sinks, one of the circuit boxes had to be replaced in the wall. They tried to call the property manager who sent them to one of their "handypersons" to get defect fixed in the house. Of course, they did not fix the many issues but, to make matters worse, they charged the Plaintiffs anything they could think of to "fix" the issues and deducted from the option money and rent. The plaintiffs contacted my office for assistance. Once we reached out to the landlord and the seller, he decided to sue us and sue the tenants for his legal fees. We filed a counter claim and an application for a temporary restraining order to stop him from evicting our client while the case was pending. At that point we had to make the hard decision as a firm, to hire the defense team to help us fight the landlord while we figure out the case together.