In the last few months, I have gotten a lot of inquiries about lease-options. First, let's define the term. In a lease-option, the buyer/tenant rents the property from the seller/landlord for a specified period of time. At any point during the lease, the buyer/tenant has the right to purchase the property at a price that was pre-determined in the lease-option. To compensate the seller/landlord, the buyer/tenant gives the owner a specific amount of non-refundable option money when the option is signed. In addition, the buyer/tenant usually pays above-market rent, with a certain amount to be used towards the down payment.
Let's look at an example. Fred wants to put a lease-option on Mary's house for 1 year. Fred and Mary agree that, if the purchase goes through, the price of the home will be $100,000. Fred agrees to give Mary $5,000 option money and agrees to pay $800 per month in rent, even though similar homes are renting for $500 per month. Mary agrees to allow Fred to rent the home for 1 year. At any point during that year, Mary agrees that Fred can buy her house for $100,000. In addition, Mary agrees to set aside $300 per month of Fred's rent. If Fred buys the house, this $300 per month surplus will be used as part of Fred's down payment. If Fred rents for 12 months before buying, he will have "saved" $3,600 to be used towards the purchase. If Fred decides not to buy the home, Mary keeps the extra money and Fred moves out at the end of the lease.
For the seller, a lease-option may be a way to sell a home during times when home sales are slow. But there are real advantages for the buyer as well. Especially today, when mortgage money is hard to come by, credit and income requirements are tougher, and mortgage lenders want to see more down payment money, a lease-option allows a buyer/tenant the time to work on his credit and down-payment savings, while securing the property he wants to buy now.
Other advantages for the buyer/tenant include the ability to live in the home and community before permanently committing to them. This gives the buyer/tenant the chance to try out both the house and the neighborhood to see if he really likes living there. Also, the lease-option acts as a price shield. If prices continue to fall, the buyer/tenant can walk away at the end of the lease without buying. If prices go up, the seller/landlord is locked in to the agreed upon price.
The lease-option agreement must be carefully crafted to make sure that all parties are protected and that no one is paying too much or too little for the purchase, the option money, or the monthly rent. But the biggest risk is one of foreclosure. If the seller/landlord loses the home to the bank during the option period, the tenant/buyer has no recourse other than to sue the seller/landlord. If the seller/landlord has just gone through foreclosure, chances are he doesn't have a lot of money, so even if the buyer/tenant wins, he may not be able to collect.
Before you enter into the lease-option, you can try to protect yourself by investigating what loans are presently on the property and how much the seller pays each month. If their monthly mortgage payments are much higher than the rent, the seller may have problems meeting their obligations. If you do enter into a lease-option, you may want to record it with the County Recorder. That way, if the seller tries to get another loan, the new lender will be notified of the lease-option.
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