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All
about Lease Options |
Is a lease
option the right choice for you? Read on to learn about
lease-options and the benefits they may offer you as a buyer
or seller!
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A lease
option (also known as, lease to own, rent to
own, or rent to buy) is a combination of a conventional
leas e, a purchase agreement, and
an option contract to purchase
the property at a future date, usually at
pre-determined price. At the end of the lease term,
the tenant becomes the buyer,
and the landlord becomes the seller.
Lease-options are typically used by home
sellers during periods of declining home prices or
slow sales. They are rarely offered during periods of
rising home prices or rapid sales, since sellers
benefit more from selling immediately.
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| Benefits - A lease option
can have many benefits. In a perfect world, a
lease-option benefits both the buyer and the seller.
The tenant (buyer) is able to lock down a home and
perhaps put their financial house in order before
taking on the extra responsibilities of home
ownership. The tenant can also give the home a
"test drive" before deciding to purchase.
The landlord (seller) receives cash-flow from the home
during the lease period and a sale at or near market
price, at the end of the lease term. However,
lease-options can hold certain advantages or
disadvantages for each party (as I will discuss
below). |
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Your goal - Always remember
that your objective will be to purchase the home at
the end of the lease. Most lease-options are used by
people who do not qualify for a home purchase due to
poor credit, lack of funds, etc. If they do not change
their financial habits or manage to save enough money
during the term of the lease, they risk losing their
option money along with the purchasing credits of
their rent payments. If you have financial issues, you
should not enter into a lease-option contract unless
you can be reasonably certain that you will have
enough cash for a down payment and that you will be
able to qualify for a loan. To avoid surprises, always
consult with a qualified real estate professional and
a mortgage loan specialist before entering into a
lease-option contract. |
Basics of a
Lease-Option
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The buyer pays the seller option
money called "Option Consideration" for the
right to later purchase the property. The lease option
money may be substantial and it is non-refundable if the
buyer does not exercise the option.
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The buyer and seller may agree to a
purchase price now or the buyer may agree to pay market
value at the time the option is exercised. It is
negotiable. However, most buyers want to lock in the
future purchase price upon inception of the lease option.
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During the term of the lease option,
the buyer agrees to lease the property from the seller for
a predetermined rental amount.
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The term of the lease option
agreement is negotiable, but the common length is
generally from one year to three years.
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The option consideration money
generally applies toward the toward the purchase of the
home.
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A small portion of the monthly
rental payment also applies toward the purchase price.
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Option money is rarely refundable.
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Nobody else can buy the property
during the lease option period.
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The buyer generally cannot assign
the lease option without seller approval.
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If the buyer does not exercise the
lease option and purchase the property at the end of the
lease option, the option expires.
-
The buyer is not obligated to buy
the property at the end of the lease term.
Advantages and
disadvantages of Lease-Options
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Ideally, a
lease-option will be a "win-win", benefiting
both the buyer and the seller. However, there can be
certain advantages or disadvantages to each party,
depending on variables such as future real estate
market conditions, the tenant's financial situation,
etc. Here is a recap of the possible advantages or
disadvantages for the buyer and seller: |
Advantages for
the Tenant (Buyer)
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It allows you to lock in a home of
your choice for future purchase
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No one else may purchase the home
while you hold an option contract
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It buys you time to get your
financial house in order (save for a down payment, repair
credit, etc)
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You may gain additional equity if
the market value of the home increases
during the lease period
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You have the option to back out if
you find a better home, or if you cannot qualify for the
purchase
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It's a form of savings - Some of
your rent payments may be applied toward the purchase of
the home
Disadvantages
for the Tenant (Buyer)
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You will lose your option
money, plus the credit value of your rent payments if you
decide not to exercise the option
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You may not qualify for a
loan if you have not improved your financial situation
during the lease period
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The value of the home could decrease
during the lease period, causing your purchase price to
exceed the fair market value
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You are locked into one home
- You lose the flexibility to shop for and negotiate on
other homes
Advantages for a
Landlord (Seller)
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The market value of the property may
decrease during the lease period, rendering
your option price more valuable than current market value
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You get to keep the option money if
the buyer decides not to buy the home
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You get income during
the lease and a sale at the end of the lease
term
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It allows you to lock a purchase
contract at a fixed price during a slow market
Disadvantages
for a Landlord (Seller)
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The market value of the home may
increase during the lease period, rendering your
option price less valuable than if you sold at current
market
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The buyer might not exercise the purchase
option, forcing you to re-list the home for sale or lease
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You cannot entertain other purchase offers
while a tenant holds a lease-option on the property
Lease-option
FAQ
What is the
difference between a lease-option and a lease-purchase?
A lease-option contract
offers you the choice of buying the home at the
end of the lease, while a lease-purchase agreement obligates
you to buy the home. The risks also differ. Should you fail to
exercise a lease-option, you will lose only your option money,
but under a lease-purchase you would be in a breach of
contract since you are obligated to complete the purchase.
Lease-options can be beneficial to both buyers and sellers and
are popular in times of falling home prices or slow sales.
Lease-purchases are clearly a benefit to sellers but are far
riskier for buyers, therefore they are rarely done.
Return
to questions
Am I better off with a lease-option or just a
straight lease?
| It really
depends. In a lease-option, you'll need to ensure that
you are financially prepared for the purchase at the
end of the lease term. If in doubt, go with the straight
lease to avoid losing your option money. Also,
be sure that this is home you want to buy. If you are
new to the area or not sure about the home, you might
want to keep your options open and shop for other
homes while you're in a lease. On the other hand, if
you love the home and feel you will have the financial
wherewithal to purchase it, a lease-option is
a great way to go, since part of your rent goes toward
the purchase and no one else may buy the home while
you hold the contract. |
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Return
to questions
Since a lease-option involves
certain risks, wouldn't it be wiser to start with a straight
lease and negotiate the home purchase afterward?
Possibly,
but there are certain risks to this approach also.
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There is no
guarantee that you will able to purchase the home at the
end of the lease. The homeowner may decide to sell to you,
but he is also free to market the property to anyone and
to sell to the highest bidder, or, he may choose not to
sell at all. Under the terms of a lease-option, you hold
the exclusive right to purchase the property
if you qualify.
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The homeowner is
under no obligation to apply any part of your rent toward
the purchase of the home, as he would be under a
lease-option agreement.
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If the home
appreciates during the term of the lease, you could wind
up paying a higher price for the home than
you would have, had the price been "locked"
under a lease-option agreement.
Return
to questions
I would like to go with a lease-option. How can I
tell if I'm financially prepared?
Consult with a lender or
mortgage loan specialist. They will run your credit report,
review your income, savings, and assets, and discuss available
loan programs with you. If you are qualified, your loan
specialist may provide you with a pre-approval letter,
which you can present as part of the lease-option application
package. On the other hand, there may be areas that require
improvement such as credit scores, reserves, etc. In this
case, you may want to work on getting your finances in order
before taking on the greater risk of a lease-option.
Return
to questions
Which contracts are required for a lease-option?
A lease-option requires three
contract forms: a lease contract, a residential purchase
contract, and an option contract, which defines all of the
option terms. Be sure to go over the details of each contract
carefully with your real estate professional, and do not be
afraid to ask questions! A lease-option is a big commitment,
so make sure it is the right choice for you!.
Return
to questions
What
are the various option terms?
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The purchase price - Fixed price or market
price at the time of purchase
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The amount of option consideration
money
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The amount of monthly rent during the lease
period
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The amount of rent credited toward the home
purchase
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The length of the lease period
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Closing costs
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Termite and physical inspections
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Appraisal considerations (what will happen if
the property fails to appraise for full purchase price)
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Future appreciation or depreciation
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Other terms requested by buyer or seller
Return to questions
What
is the typical amount of "option consideration"
money?
It can be as low as 1% to as
much as 5% or more, of the purchase price of the home. For
example, on a purchase price of $650,000, the lowest it would
usually be is $6,500, but it could be set at $10,000, $15,000,
or much more. The cost is set by the seller but it is
negotiable.
Return
to questions
Are
the option terms negotiable?
Yes, all of the terms are
negotiable between the buyer and seller. However, both parties
should ensure that they are represented by knowledgeable agents who will look out
for their best interests when drafting the agreement.
Return
to questions
What
if the value of the home decreases considerably by the time
the lease is up?
Move on! You might
forfeit your option money but a steep market decline will cost
you a lot more. If your purchase price is unrealistic, take
the loss and buy a different home at fair market value.
Return
to questions
What
if the home has appreciated substantially during the lease
term. Can the landlord back out of the deal?
 |
As long as you signed a residential purchase
agreement, it's your gain if the current market value
exceeds the purchase price. The landlord could risk a
breach of contract lawsuit by failing to honor the
agreement - All the more reason to be sure to use a
qualified real estate professional to assist you.
Don't go it alone! |
Return
to questions
Are there other variations of a
lease-option?
A lease-purchase
is similar to a lease-option, with the exception of the option
itself. The buyer leases the home for a specified period of
time and then is obligated to purchase the home at the
pre-determined price.
A
lease with first right of purchase is a more informal
arrangement in which the tenant has the first right to
purchase the home at the end of the lease contract, but at
fair market value. There is no option consideration money and
no locked-in purchase price. The buyer and seller negotiate
the purchase price just before the lease term expires and if
they come to agreement, they go into escrow. If not, the
seller is free to re-market the property on the open market.
Return
to questions
Related links:
I hope this
article has answered some of your questions about
lease-options. Do you have a question that was not
addressed here? Please feel free to contact me! I will
be happy to assist you with a lease option or lease to
own property in Orange County, CA, as well as a sale,
purchase, lease, or rental. I will also put you in touch
with a loan specialist who can help you qualify for the
purchase. I am a real estate specialist in South Orange
County, California, including Coto de Caza, Dove Canyon,
Rancho Santa Margarita, Mission Viejo, Ladera Ranch, Las
Flores, Rancho Cielo, Walden, Wagon Wheel, Laguna
Niguel, Robinson Ranch, Foothill Ranch, Portola Hills,
San Juan Capistrano, San Clemente, or the Santiago
Canyon areas (Modjeska, Silverado and Trabuco Canyons).
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Copyright © 2007.
CDC Technology, Inc. All rights reserved . No part of this article may be copied without
the express permission of the author, Ron Denhaan,
Realtor, Prudential California Realty |
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The information herein
was written by Ron Denhaan, Realtor, Prudential California
Realty, and represents the opinions of the author. It does not
necessarily reflect the views of other real estate agents,
associations, or of Prudential
California Realty. While all of the information is believed to
be true, we do not warrant the accuracy of the information. We
cannot and do not warrant that the information in this article
is absolutely current, although every effort is made to ensure
that it is kept as current as possible. This article pertains
only to common real estate practices in the State of
California, USA. No part of the article should be construed as
representing actual legal advice - Always consult appropriate
professionals, such as qualified attorneys, financial
advisers, and real estate brokers.. A lease-option may not be
right for everyone. People who cannot meet the financial
requirements to complete the home purchase should not enter
into a lease-option contract. |
