Lease Option

LEASE OPTION

In a market that is over-stocked with listings, how can an investor or homeowner, whose property is setting vacant and unsold, make his property stand out from all the others in the same boat? One strategy that makes very good sense is to offer financing that is not readily available from lenders and other sellers.

One of these types of financing is a lease-option. The seller realizes a higher return rate over the long term than if he had sold the property out-right. The buyer is able to contract for a future purchase and move into a home at a time when his credit might prevent him from doing so.

The very condensed version of a lease-option works like this: The seller sets a price, determines a fair-market rental price, and decides how much he wants in option money. Example: Price is $400,000, option amount is $25,000, and a fair rental is $2500 (which doesn’t cover his payment, but that’s the reality of Las Vegas real estate right now.) The seller and buyer sign a contract with a close date two years in the future. The buyer gives the seller $25,000, and rents the property for $2500 per month. However the buyer’s payment is actually $3000 per month. The extra $500 per month is credited to the buyer as part of his down payment. At the end of two years, the buyer has accumulated a credit of $37,000 toward his down payment, the original $25,000 and the $500 per month for 24 months. In the correctly executed lease-option, that money will be credited to the buyer by a lender for the purpose of securing a loan. Very good records must be kept for the lender. However, if the buyer defaults, the $37,000 is forfeited to the seller.

Pitfalls for the seller in this scenario include destruction to the property by buyers who then default, buyers who declare bankruptcy and are allowed to remain in the property without paying rent until the bankruptcy judge decides they should go, a market which escalates faster than the seller anticipated and he finds himself selling the property at two years ago prices, and property that depreciates, so the appraisal the buyer must obtain to get his new financing will not support the agreed upon contract price. The advantages for sellers include a quicker sale of the home, more money received for the home, the ability to sell the home multiple times if the buyer defaults, and a lease option does not require a judiciary or statutory foreclosure.

Buyers may encounter problems when sellers unilaterally try to change the terms of the original contract, especially when prices have risen dramatically. A seller may take the option money, rental plus credited down payment money from a buyer, and neglect to make the payment on the property, thus causing it to go into foreclosure. The most common problem for the buyer is being unable to qualify for a mortgage to finance the property at the end of the two years. An advantage to the buyer would be getting into a home even though he did not have the finances or credit required to obtain a loan, and a contract on a property that may appreciate while he’s in it, but an agreed upon sale contracted at a lower price.

These are very general rules of thumb. Each contract is subject to the stipulations stated in it, and to all applicable laws. If you are involved in a lease-option and do not understand it, you should consult an attorney.