A New Lease-Purchase on Life
For Homes That Aren't Selling, It Is An Option, but Risky

By Mara Lee
Special to The Washington Post
Saturday, May 17, 2008; F01

The timing was all off for Catherine McAlpine and her family.

She and her husband, Richard Eig, bought a house on a double lot in their Rockville neighborhood in September 2006, at the high-water mark for prices. They planned to renovate the house and sell it, and build a house for themselves on the extra lot.

"Of course we thought we'd make a little money," Catherine McAlpine said. "We didn't anticipate the changes in the market."

When the house was listed at $469,000, there were no bids. The family dropped the price to $448,750 three months ago, and still no bids, even though a house across the street sold recently for $455,000.

They're finding that few people have $50,000 saved for a down payment, so they're going to try a lease-purchase agreement, sometimes called rent-to-own. These arrangements become more popular in difficult real estate markets because they widen the pool of potential buyers.

In a lease-purchase deal, a tenant agrees to buy the house at a set price by the end of the lease. Often, part of the rent goes toward a down payment and the tenant puts down a larger deposit than usual, which will also apply to the down payment.

There are also lease-options, whereby the tenant has a similar arrangement but is not obligated to buy the house at the end of the term. In both lease-purchase and lease-option situations, the extra deposit and rent generally are not refundable if the sale does not go through.

The agreements are attractive to people who would like to buy a house but don't have enough savings to qualify for a loan or who are waiting to sell another house to use the profit as a down payment.

For the sellers, such deals carry risks.

Roger Hayden, a Maryland real estate lawyer with 25 years of experience, said that if a buyer doesn't go through with a lease-purchase, it would probably cost the seller more to hire a lawyer to collect damages than the damages are worth.

Depending on the reason the tenant wasn't qualified for a mortgage at the beginning, that can still be a problem at the end.

Hayden said that when the buyer-tenants have damaged credit or not enough savings when they enter the lease, they often still cannot qualify for the purchase a year or two later.

Not many of those arrangements go through to a sale, he said. "I don't like them for myself," he said.

And those pitfalls are in addition to the normal risks of rental properties -- damage to the property, late rent or nonpayment of rent.

Michael Brown, who is using a rent-to-own arrangement on a house in Manassas that he bought from a bank in May 2007, said his buyer-tenant family has been more reliable than the other tenants he has, most of whom have paid late or been short at times.

Market rent is $2,500 for the Manassas house, Brown said. He at first agreed to $2,600 rent, with $200 a month applied to the down payment.

Brown's tenant didn't have $2,600 ready for the first month's rent after putting down a $5,000 deposit, so Brown lets him pay from each paycheck and charges $2,800 because the tenant is paying for the previous month rather than the month ahead.

That $2,800 is just enough to cover an interest-only mortgage payment for Brown. When all his tenants pay on time, he pays more toward the mortgage.

Brown said that when he bought the house, similar ones were selling in the $460,000s. He and the tenant agreed 10 months ago on a $499,000 price eight months from now.

The contract says the sales price is contingent on an appraisal at that price, and Brown said he will consider selling at a lower price if it doesn't appraise -- "if it covers all my costs."

"I haven't seen a downside, especially in a soft market," he said.

Jared Martin, a mortgage broker at the Alexandria office of

GOTeHomeLoans, said lease-purchase makes sense if you're a buyer who needs to sell your old house, because bridge loans have dried up.

But he said that if you're a tenant-buyer because of damaged credit, renting to own could provide false hope. Commercial banks are expecting a healthy credit score of 680, and in Manassas and other declining outer-suburban markets, at least 15 percent down.

The Federal Housing Administration will insure loans for buyers with credit scores as low as 640, he said, and requires a down payment of as little as 3 percent. Sellers are also allowed to pay a substantial portion of closing costs.

He said that, depending on the reason for the low credit score, it's unlikely to improve significantly in a year or 18 months. If it's low because of high credit card balances, those can be paid down, but poor payment histories fall off a report gradually.

For Brown's buyer-tenant to keep his payments at $2,800 a month after buying, assuming 3 percent down and a 6.5 percent rate, he would need a sales price of $405,000 -- and that's not including $177 a month for the FHA insurance, Martin said.

Robert Peralta has been trying to sell his three-year-old house in Southern Maryland for 10 months. He's selling because of a divorce. The house was bought with no money down and a five-year, interest-only, adjustable-rate first mortgage.

He wanted a buyer-tenant to pay $2,700 in rent, with $200 monthly credited to the down payment, and a hefty deposit.

"Nobody was really willing to put up that kind of money," he said. "The majority had bad credit or were going through foreclosures," and he didn't think they were risk-worthy, he said.

Peralta, who is asking $425,000 for the four-bedroom house, is thinking of lowering his price again in hopes of finding a traditional buyer, although he's still open to a lease-purchase.

Peralta is charging more than enough to cover his mortgage, but that's not possible for Peter Princiotto, who lives in McLean. Princiotto bought his house in 1984 and has refinanced several times "to make it a beautiful home." He changed the pitch of the roof, created a large music studio upstairs and added five skylights, among other projects.

His mortgage is $4,000 a month, and he is finding that he has to work all the time to meet his budget. He gives music lessons from his home.

"I don't think anyone would rent it for that amount," he said, and although he would like to sell it the traditional way for $684,000, he said, "I think it's really important to be creative right now."

He would like to set up a lease-option for $3,500 a month, with $2,800 of each month's payment counting toward the buyer's down payment.

The McAlpine-Eig family had two buyer-tenants interested in their Rockville property. One is waiting to sell a million-dollar house after a divorce; the other is a couple who sold a house out of town and had to pay the bank at the settlement table, so they don't have a down payment ready. The man going through the divorce has put down a $3,000 deposit that will go toward the down payment and will pay $2,000 a month, which is market rent but is hundreds of dollars less than their mortgage.

McAlpine said that although he seems serious -- he had a home inspection done -- he hasn't signed the purchase contract that would go into effect within a year. "I'm not as confident as I'd like to be," she said.

Unlike Brown, the couple know they won't break even on the arrangement.

"We bought the house for more than we're selling it for," McAlpine said. Not only that, but the renovation needed was more extensive than they planned. They invested almost $70,000 in new wiring, central air and heating, a new kitchen, new staircases, and new closets.

"For us, it's been a live-and-learn situation," she said.

Frank Jamison sold a house through lease-purchase in 1989. He received a $10,000 deposit and market rent plus $100, with the extra going to the down payment. The buyers were Air Force doctors who had transferred from Hawaii and were waiting to sell a house there. They bought the house four months after moving in.

Jamison, owner of Jamison Real Estate in Poolesville, said he has also helped sellers with lease-purchases and has never had one fall through -- but none of the tenants had damaged credit.

He is considering a lease-purchase again, although he would rather sell now if he can get the same price.

"When you get into one these things, you've got a partner," he said. "They've got complete control of [your house], and you've got a maybe."