If you are having a tough time selling or purchasing a home, seller financing is one way for sellers to attract buyers and for buyers with bad or no credit to own a home.
One of the most popular owner financing deals is the lease option, also known as the “rent-to-own” transaction.
What is a Lease Option?
Simply put, the lease option is a type of real estate transaction wherein the purchaser leases the home for a stated amount of time before choosing whether or not to exercise a pre-determined option to purchase it at the end of the lease.
There are two contracts involved in the lease option: a lease and an option contract. The lease is generally a standard lease, outlining how long you will lease the home and your rent each month. The option kicks in at the lease’s conclusion. For instance, if the lease period is two years, you have the option to purchase the property within that time period.
Advantages of Renting a Home With the Option to Buy
Renting a home before purchasing it has the obvious advantage of giving you a “trial run.” You will know by the time your lease is up whether or not it’s the home for you.
Other advantages for buyers include:
Forced saving for your down payment: Even those with the best of intentions may find it difficult to save for a down payment on a house. In the lease-option situation, the excess amount you pay in rent every month is set aside by the landlord/seller to accumulate during the lease period.
Time to fix your credit: Whether you opt for a one-year or a three-year lease, this time can be spent fixing or building your credit. That way, when the lease is up and it is time to pursue a mortgage loan, you’ll be all set to qualify.
No huge down payment required: Unlike the 20 percent or more down payment required in a traditional home purchase, a typical lease option transaction calls for first and last month’s rent and an additional option deposit. The amount of that deposit is negotiable.
Here are some lease option terms you should familiarize yourself with:
Term: The lease’s term is the length of the lease. Term is always negotiable. If you think you’ll need two years to save for a down payment or to fix your credit, then you will want to negotiate at least a two-year lease term.
Payment: This is the amount of rent you will pay each month. Again, this is negotiable but the rent will typically be above the average for the market.
Rent Credit: This term describes the amount of rent that the landlord/seller will set aside for you to use as a down payment or towards closing costs when you exercise your option to purchase. Should you decide to not exercise the option, you will lose this money.
Lease Option Fee: The lease option fee is the cost of the option to purchase the home. The fee is negotiable and is typically, but not always, 1 percent of the purchase price. The option contract should specify whether or not the option fee is refundable (generally option fees are not refundable) and whether it will be applied to the purchase price should you exercise the option.
Option contracts vary in the terms used, depending on who is drawing them up. Keep in mind that there are certain elements all real estate contracts must include:
- Parties: The full names of all parties to the contract must be included
- Property: The property must be identified with the address and, as added protection, the legal description.
- Consideration: To be legally enforceable a real estate contract must include what is known as “consideration.” According to attorney and author, John N. Beck, II, although the accepted definition of consideration to most real estate agents is the deposit, the true legal definition concludes that consideration, on the part of the buyer, is “any benefit conferred …” to the seller. Thus, the mere commitment to purchase the property may qualify as consideration.
- Purchase price: This is the amount that both parties have agreed to, subject to an appraisal when the option is exercised.
- Closing date: All contracts must include a date of conclusion.
The real estate contract must be signed by all parties to be legally enforceable.
Of course, this is a basic look at the lease-option transaction. There are many variations and the process may be full of pitfalls. Superficially, however, it seems like an easy process, which lulls many buyers into the DIY mode.
It is important to understand both the lease and the option contract, in full, before signing either document. Your best protection is to spend an hour or two with an attorney to make sure you are fully aware of the details.