When a person rents with an option to buy, he or she rents a home from its owner and lives in the home as a tenant until he or she exercises the option to purchase the home and become the owner.
A contract to lease with an option to buy, called a lease purchase or lease option agreement, is a typical rental agreement but for the option clause. Usually, the option clause allows the renter to purchase the home at any time or at certain time intervals (after three years of paying timely rent, for example) by serving the owner of the home with written notice of his intent to exercise the option. Generally, the clause also gives the renter the right of first refusal, which means that the owner of the house cannot sell it to a third party unless the renter has first been offered and declined to exercise the option to buy. Typically, upon signing the contract, the renter must pay the owner a non-refundable lease option deposit. The option can be drafted so that there is only certain time period during which it can be exercised (30 days after the first of the year, for instance) or so that it expires completely after a period of years.
There are many advantages to leasing with an option to purchase for both the buyer and the seller. Because the terms of a lease purchase agreement typically apply all rent paid to the cost of purchasing the home, the seller is essentially financing the purchase of the home. This allows the buyer to purchase a house without an extensive credit and finance check, and the seller to sell her home quickly and still get all or nearly all of her asking price (this is especially beneficial during a sluggish market). Depending on the market, the buyer can negotiate lower rent (in exchange for making higher mortgage payments later) or the seller can negotiate higher rent because he is basically financing a purchase. (This aspect really depends on the negotiating skills of the respective parties). As well, such a contract is relatively risk-free for both sides. The first right of refusal clause prevents the owner from selling the house out from under the renter. The option deposit and time limits allow the owner to still make a sale if the renter is unable or unwilling to purchase the home.