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Lease to own options - by Jennifer Mackay

With the current economic situation through out the world, lease options and lease purchases are becoming more common every day.

Lease purchase agreements may be considered by sellers of hard-to-sell properties or during times of economic down turns.  When a property is difficult to sell for whatever reason, the seller would be able to obtain a buyer with a conventional mortgage from a lender to purchase the property.  As lenders require more stringent terms and offer fewer options for buyers, buyers often turn to lease options and lease purchases to obtain home ownership.

If you’re a cash-challenged potential home buyer, a lease-to-own agreement may be an option of buying a home and accumulating a down payment.

Let’s examine some of the benefits of lease options and lease purchases for both sellers and buyers.

So what exactly is a lease-to-own or lease-option agreement?

A lease-option agreement is a lease that allows a potential buyer to occupy a home as well as providing an option that allows the buyer to purchase the property in the near future at an agreed-upon/negotiated price.

The borrower will often pay an option fee of 1% to 5% of the purchase price, which may and usually is credited towards the purchase price.

Typically, a lease-option agreement requires a buyer to pay a higher monthly rent/lease amount for a home and obligates the seller to credit a portion of the rent/lease amount toward the down payment of the property. Example: If a seller expected to receive a current monthly market rent of $1,500, the seller may consider increasing the amount to $1,800 per month and apply $300 per month to a potential buyer’s down payment. After one year, the buyer would have a down payment credit of $3,600 (12 months x $300 per month).

There are several benefits to both parties in a lease purchase transaction.  Let’s examine some of the more common benefits to both.

Seller Benefits and short comings:

    •  Sellers will generally obtain market value at today's real estate prices while gaining relief from paying a mortgage on a vacant or unwanted property.

    • If a buyer defaults on a lease agreement to purchase, sellers typically do not refund any portion of the lease payments nor the option money and may retain the right to sue for specific performance.

    • The seller’s ability to sell the property to another potential buyer during the term of the agreement is removed or restricted.

    • The seller is responsible for any and all property taxes, insurance, repairs and maintenance of the property during the lease-option term since a buyer has no actual ownership interest in the property.

  • The seller/owner of a property would suffer any and all losses if the property were damaged or destroyed due to natural disasters occurring during a lease-option term. 
Buyer Benefits and short comings:

While potential buyers need to be especially careful regarding lease purchases, the lease-purchase plan has a sound economic basis, meaning the contract can be structured to the benefit of both parties.

    • A lease option provides buyers a chance to check out a neighborhood and occupy the home before deciding whether to finalize the purchase.

    • Although lease payments may exceed the local rental market, lease options provide a buyer the means to obtain a down payment.  In addition, the buyer is speculating the property will appreciate beyond the agreed upon purchase price.

    • Buyers will typically provide a down payment, with little or no qualifying.  This appeal makes a lease purchase a way for potential buyers to ease into the benefits of home ownership.

    • Buyers also receive a type of required savings plan, as part of the lease payment may be credited toward the purchase price at the end of the lease option agreement.

    • Buyers may want to purchase separate renter’s insurance to cover personal belongings and other items not covered in a seller/owners insurance policy.

    • Once the property has been purchased at the end of the lease-option term, the buyer is responsible for all applicable taxes, insurance, and repairs related to the home.

  • If a buyer elects not to exercise the option to purchase the property, any credited rent/lease amount is usually forfeited to the owner. This money then becomes a means of compensation to the seller of the property.
A lease purchase agreement is not a guarantee or an obligated sale.  There are various reasons why a buyer would opt out of a lease purchase agreement.  Here are just a few:

  • Lower property values in the area – as market changes occur, property values may decrease due to various changes in the neighborhood.
  • The inability to obtain a mortgage – many buyers using lease options does so because they may not qualify for a conventional mortgage from a lender.  The lease option provides the buyer a time frame to “repair” any credit deficiencies.  However there may not have been enough time to complete all the necessary credit requirements from a lender.
  • Change of life circumstance – Many times a job transfer, new addition to the family or other life changing event may require the buyer to opt of a lease agreement.
The basics of an "Option"

There are many potential options in a lease purchase agreement.  The following options are most common and are but a few that can be found in lease purchase agreements:

  • The right to purchase a property later - This option provides the buyer a way to purchase a property at a later date.  The buyer pays a negotiated amount also called the “option fee” for this right in advance.
  • Purchase now or pay market value later - With this option, both buyer and seller attempt to agree when an option is exercised.  This tends to be a more speculative option since property values are fluid.
  • Term option – This is an option in which the term of an agreement is negotiated.  Typically, one would expect to see terms of one to three or more years.

In addition to options, stipulations are often part of option clauses.  Here are a few common stipulation clauses for options:

  • Non refundable Option payment - Money used to negotiate an option such as a down payment is rarely refundable.
  • During the option period, no other buyers are permitted to buy the property unless the buyer defaults.  When a buyer defaults, various consequences may become active; all money paid by the buyer may be lost, buyer may be evicted according to the terms of the agreement as well as other consequences agreed upon at the time of contract signing.
  • Transfer or assign - The buyer may be given permission to sell, assign or transfer their option to a third party.
  • Option Expiration - If the buyer fails to exercise the option and does not purchase the property before the expiration date of the option, the option expires.
  • Obligation - Options often exclude the buyer from their obligation to purchase the property.  It is called an "option" for this very reason.  If the buyer fails to exercise the option within the given time frame, the property is retained by the seller and the buyer may lose all rights to purchase the property as well as any money that has been applied toward the purchase price.  A lease option is an opportunity for a buyer to purchase property at a known price and provide a means for rent credit which is applied towards the down payment of the purchase.
Often times, an option is set in motion based on a buyer’s ability to lease a property prior to purchasing.  Let's examine a few lease options:

  • During a lease option, the buyer and seller may agree to the purchase price at the time of lease signing or the buyer may agree to pay market value at the time the option is exercised. Typically, most buyers want to lock in the purchase price at the acceptance of the lease option.
  • During the term of a lease option, the buyer agrees to lease the property from the seller for a predetermined rental amount.  Some lease options will provide a portion of the rental money to be applied towards the payoff amount while some will not.
  • The length of a lease option agreement is negotiated prior to signing an agreement. Typically, the length of a lease option is from one year to five years.  At some point during the lease term, the buyer will apply for lender financing.  At the time of financing, the buyer pays the seller in full for the remaining balance of the negotiated price for the property.
  • The option money generally does not apply toward the down payment but is provided to the seller as incentive to permit the lease option.
A Lease Purchase

A lease purchase differs from a lease option in that it is an agreement to purchase based on a contracted agreement where as a lease option holds the “possibility” of purchase.

  • Buyer and seller negotiate the purchase price which is often at or a bit higher than market value.  This is often due as part of the incentive for a seller to permit an option.
  • Buyers are often held responsible for maintaining the property and paying all expenses associated with its upkeep, repairs as well as taxes and insurance.
  • The buyer is obligated to buy the property.
Contracting a Lease Option / Lease Purchase

A lease-option agreement should be formalized in a written/signed contract specifying the following at a minimum:
  • Monthly rent
  • Amount of rent that will be credited toward the down payment
  • Final sales price
  • Expiration date of the option.

Any and all contingencies and other pertinent terms of the lease agreement should be stated in the contract as well.  You are entering into a binding contract and it is of the utmost importance that all expectations are identified and agreed upon prior to signing the lease agreement to purchase.

It is always recommended to hire a real estate attorney when contracting a lease option or purchase option.  An attorney who is educated in state and local real estate law will:
  • Draw up the documents
  • Explain the rights of all parties which include rights of possession as well as any and all default consequences.

Real estate agents are not always involved in the exercise of lease options or fulfillment of lease purchase agreements.  Using a real estate agent does not preclude the necessity for obtaining legal counsel. Real estate agents are not lawyers and cannot provide legal advice. 

While a lease-option may not require the services of a real estate agent/broker, the transaction is entered into without the benefit of a real estate agent/broker’s advice, expertise and assistance.  Therefore, unless you are a proven negotiator, experienced investor and are an expert in the local real estate market, it is highly advised to use a real estate agent in guiding you in these types of transactions.

Sellers may give option money to their real estate agent as full payment of commission and buyers may opt to pay a Consultation fee when entering into lease option or lease purchase arrangements.

Protecting yourself

When executing a lease purchase, it is necessary to obtain all applicable disclosures.  Prior to closing it is imperative you complete your due diligence as you would on any real estate purchase. This includes but is not limited to the following:

  • Obtain a home inspection – It is of paramount importance that a buyer understands any physical defects of a property or items which will or may require replacement or repair.
  • Examine the title policy – This can be accomplished by a title company.
  • Obtain an appraisal – This is required by most lenders.  However, since the seller will be acting as a short term lender, often the buyer will be required to pay for this option.
  • Read all seller disclosures – Now is the time to find out if there are any issues the sellers are aware of regarding the property.
  • Negotiation of closing cost payments and transfer fees etc.
  • Consider obtaining pest inspections, a roof certification, home warranty plan and hiring other qualified inspectors.

As lending institutions and government regulations make it more difficult for buyers to obtain conventional mortgages, lease option and lease purchase agreements become more popular and sought after alternatives.

Lease options and lease purchases are not a new concept in the real estate industry and tend to more prevalent during economic downturns such as recessions.

Consult with a real estate attorney as well as a real estate agent.  These consultations will provide you with the needed information and education to make your purchase as easy and legal as possible.

You can always obtain more information by contacting me directly at 850-774-6582 and I'll help you with the details.

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Jennifer Mackay REALTOR®
Keller Williams Success Realty
2110 W. 23rd Street, Suite A. Panama City Fl 32405
Direct: (850) 774-6582
Office: (850) 392-1700
Fax: (850) 522-3697
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