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Dr. Don Taylor, CFA, Bankrate.com advice columnistBe cautious with lease-purchase deal

Dear Dr. Don,
With the high prices for homes in Southern California, we've been looking into other alternatives to be able to purchase. But with median home prices approaching $600,000, what do you think about renting-to-own?
-- Grace Gravitate

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Dear Grace,
A lease-purchase agreement on a home can be a win-win contract for both the homeowner and the lessee. The big questions here are: Do you want to lock in a price when the market looks like it's starting to soften and mortgage rates are poised to head higher? And what are you willing to pay for that privilege?

The contract can be structured in a multitude of different ways, but it's common for part of the monthly rent payment to be applied to the purchase price of the home. That allows you the potential to build equity while still renting.

The option to buy the home out of the lease is generally in place for the term of the lease. The price paid for that option is set at the beginning of the lease term, along with the price of the house, etc. In some contracts the option price is a set, nonrefundable dollar amount. In others, it is built into the monthly lease payment.

You need to look at the seller's motivation in arranging a lease-purchase agreement with you. By providing a lease-purchase option, they may be able to set a sales price for the home that is higher than the price they would receive from a cash buyer or a person using conventional mortgage financing. That above market price is part of your cost for the option, should you eventually buy the home. Paying above-market rents is another explicit cost of the option.

Sellers would prefer not to use lease-purchase financing, even with the higher rents and the option money. In hot markets it's not widely used, so you should be cautious in entering into this contract. You know your local real estate market better than I do, but using a lease purchase to lock in today's price on a home may not be to your advantage.

To ask a question of Dr. Don, go to the "Ask the Experts" page, and select one of these topics: "financing a home," "saving & investing" or "money."

Bankrate.com's corrections policy -- Posted: June 15, 2006
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