A lease-option (or lease purchase) is often associated with a real estate transaction primarily consisting of two components: a lease agreement and a purchase option agreement. The two documents work in tandem to create the overall effect for tenants to have legal use and possession while keeping their position to receive transfer title. There are two ways this may be achieved: by qualifying for a new loan so that the lanlord/seller may be bought out or by creating a contract that allows the renter to lock in the purchase price for several years.
The two parties involved are a lessee, one who rents to own, and a lessor, the owner of the property. In addition to the purchase option contract that the lessee pays a sum for, the lessee pays the lessor rent – typically in the amount of the mortgage or greater. Proceeds are sometimes applied towards the purchase price. There is no universal way to implement a lease-option transaction as it is highly adaptable to both the buyer and seller’s needs. The actual terms and documents can vary greatly from one practitioner to another. 
The Lease-option, usually having 2 documents, places an emphasis on the Purchase Option agreement which specifies terms for transfer of title.
If you’re ready to buy the home of your dreams, but your credit or savings isn’t quite ready yet, a lease with option to buy (often simply called a “lease option” or, somewhat inaccurately, “rent to own”) may help you move in. Lease options, in which you lease (rent) a property and have the option to buy the property at the end of the lease term, can allow you to control a home that you want even if you don’t enough money for a down payment yet. A lease option may also be helpful if you need some time to improve your credit before you can get a good mortgage rate.
Determine if a lease option is a good option for you. Lease options can be useful home-buying tools, but they’re not for everybody. In fact, the majority of lease options do not end with the lessee (the renter or prospective buyer) purchasing the home, and while that’s sometimes for a good reason, it’s often just a waste of money. Ask yourself a few questions before you decide to pursue a lease option in general or before you sign one on a particular house..
Can you afford the option money? The option money or option fee is required for a lease option contract to be valid. This upfront payment may be quite small (equal to one or two month’s rent, for example), or it may be 3-5% of the purchase price. All of this money should go toward the purchase price or down payment on the home if you decide to buy the house at the end of the lease term, but unlike a security deposit, you don’t get the option money back at the end of the lease if you can’t purchase the house or decide not to.
Do you plan to stay in the area? Since a lease option typically costs more than simply renting, you should be fairly certain that you want to buy the house at the end of the term. If you don’t, you lose your upfront option money and any additional money in excess of the fair rental value that you’ve paid in your monthly payments.
Will you be able to secure financing at the end of the lease term? In some cases the seller will finance the purchase of the home after the lease option. Most of the time, however, the buyer will need to find his or her own financing by applying for a loan. A lease option can help you get a more favorable loan than you otherwise would be able to, but it’s no guarantee, so you’ll want to be reasonably sure that you’ll be able to qualify for a loan at the end of the term. Check with a mortgage broker or loan officer to examine your situation.
Can you afford the monthly payments on the lease.
Typically (but not always) the monthly payments on a lease will include the fair rental value plus option money that will go toward the purchase of the home. Thus, the monthly payments under a lease option will usually be more than you would pay if you were renting the same house.
Will you be able to make the monthly payments on the home and meet other expenses of ownership? Even if you’re able to get the loan, it won’t do you any good if you can’t afford to keep up with the expenses of owning the home. Be sure to factor in not only the mortgage payments, but also property taxes, insurance, and maintenance costs, all of which renters don’t have to pay.
Find a house you want to buy. Keeping the above considerations in mind, look for a house that you like and that you can afford. There are some companies that specialize in lease options, and there in some places government programs will buy a house for you and then offer you a lease option. More typically, however, you can just find a house for sale and see if the owner will consider a lease option.
Discuss the lease option with the owner. Some homeowners have never heard of a lease option, and many are suspicious of them. In addition, some sellers need a lot of cash fast, and so there’s no way they can do a lease option. Still, if you’re lucky, you or your real estate agent may be able to convince the seller to work with you.
Get a home inspection. Once you’ve found a suitable house with an agreeable seller, it’s time to get the home inspected. Get an independent professional home inspector to do a full inspection so you can become aware of any problems the house may have. In most jurisdictions the seller is also required to give you a seller’s property disclosure attesting to the condition of the home, but an independent inspection is still important. If there are problems, make sure they’re not issues that will prevent you from getting a loan, and make sure the contract specifies who is responsible for making repairs. The lessor may also offer an allowance off the purchase price to enable the lessee to make the repairs if the option to buy is exercised.
Negotiate the terms of the lease option. The purchase price, term of the lease (usually anywhere from 6-24 months), the amount of initial option money, and the amount of the monthly payments that will go toward the purchase price will all be negotiable. While you can find lease option contracts online, it’s best to get one from a local real estate agent or attorney, since laws concerning lease options vary from state to state, and there may even be local regulations. A real estate agent or attorney can help you draft the contract and negotiate the terms, and it’s important for both the buyer and the seller (lessee and lessor) that the contract be well written.
Pay an option fee and sign the contract. The option fee is the upfront “consideration” that is necessary to make the contract binding. Pay this and sign the contract only once you are sure you understand all the terms of the agreement and you agree with them. In many cases, the lease option contract will be an addendum to a regular sale contract.
Check on your insurance needs. Since you now have an interest in the home, you may require additional insurance to protect the home and cover your increased liability exposure. The laws vary from place to place, so check with your insurance agent or lawyer to find out what coverage you need.
Make monthly payments. You will make monthly payments just as you would make rent payments. In many cases, however, a portion of the monthly payment will be designated as option money. This money will go toward the purchase of the home if you decide to exercise your option to buy. It may be a small percentage of the monthly payment or it may, if you’re very lucky, be the whole payment. Again, however, the option money will generally be over and above the fair rental value, so the monthly payments will be more than they would be to rent the same house.
Make improvements on the home. If the home inspection turned up minor problems, or if the home needs a little remodeling or cosmetic care, it is probably in your best interest to try to take care of these things. By increasing the value of the home with improvements during the lease term, you earn equity (so-called “sweat equity”) in the home because the agreed-upon purchase price stays the same. This increased equity may help you get a more favorable loan if you exercise your option to buy. In essence, by increasing the value of the home you are increasing your down payment.
Apply for a loan. Don’t wait until the last minute to apply for a loan. You should begin your application process no less than 45 days in advance of the end of the lease, and to be safe you should probably start a full two months or more before you need to buy the house. A lease option will qualify you for a refinance loan with some lenders, and these are usually cheaper and quicker to process than new purchase mortgages, but in any case it’s essential to have a mortgage ready to close on the home by the date specified in the lease option contract.
In some cases the seller will finance the home. This is typically spelled out in the lease option contract. This can make purchasing the home much easier than it would be if you had to apply for a loan, but make sure the terms of the seller financing are reasonable and that you’re getting a fair shake.
Close on the home. If you’ve lined up your financing and decided to exercise your option to buy at the end of the lease, congratulations. You are now a homeowner.
A “lease purchase” usually refers to an arrangement that differs from a lease option in that the lessee is obligated to buy the home instead of merely having the option to buy it.
It’s a good idea to try to get pre-qualified for a mortgage, particularly if it’s only the lack of a down payment that’s keeping you from getting a loan. While pre-qualification can give you an idea of what you can expect when you seek a loan, it’s no guarantee that you’ll be approved for the same terms later. In addition, if you’re hoping to improve your credit profile during the lease option, you may be able to get a far better rate at the end of the lease term than you would have been able to get at the beginning.
The lessee doesn’t have to buy the property under a lease option, but the lessor does have to sell (at the agreed-upon price in the contract) if the lessee fulfills the contract and exercises the option to buy. If the lessee decides not to buy the home, he or she simply forfeits all the payments made on it.
Keep good records of your payments and expenditures. You will need a record of your payments to help you qualify for a loan, particularly if you want to qualify the home as a refinance. Additionally, good record keeping will defend you against unscrupulous sellers who try to take advantage of you by claiming, for instance, that you fell behind on your payments or missed payments.
In many jurisdictions if the total of the initial option money (the option fee) plus the option money from the monthly payments exceeds 5% of the agreed-upon purchase price, the seller must go through foreclosure proceedings if the prospective purchaser falls behind on the payments. If the total option money is less than 5% of the purchase price, the standard eviction process can generally be used. For this reason, lease options typically set the total option money at less than 5% of the price.
Some real estate agents are hesitant to deal with lease options and may discourage you from exploring this option either because they are unfamiliar with how they work or because their commission is deferred or, if option to buy is not exercised, is reduced or negated. You should be able to find an agent, however, who will be willing to work with you. If one agent isn’t helpful, find another one or go directly to a seller (either an individual or a company) who specializes in lease options.
Lease options are typically better options for sellers than most people think they are, largely because the high percentage of options that aren’t converted means that the seller has a good chance of keeping the option money and still being able to sell the house to another buyer. Of course, if the lessee does buy the house, the seller has accomplished his or her goal of selling the house and he or she has also earned a little rent money in the meantime. In addition, lease option buyers are often willing to pay market value or even slightly higher due to their unique circumstances, so the seller can be sure to get top dollar for the home.
How long should your lease be? It depends. If you want to improve your credit profile, a longer term is usually best. Lenders especially like to see stability over two years, so if you’ve been living in the same house, making payments on it, and working at the same place for that long, you may qualify for better loan rates. A longer lease can also help you build equity in the home if property values are increasing. For example, if the option contract specifies a purchase price of $100,000, but the property’s value has increased to $110,000 at the end of a two-year lease, you will already have $10,000 of equity in the home (in addition to your option money) if you decide to purchase it. On the other hand, if home prices might decline, a long lease can leave you with no equity, even after you’ve been paying option money for two or more years.
This article is a general guide only and is not intended to replace professional financial or legal advice.
Make sure your lease option contract specifies a fixed price for the purchase of the home. If the price isn’t fixed when the contract is signed, you’ll almost certainly get ripped off. Make sure, also, that the fixed price is reasonable. While it’s not uncommon to pay 5-10% more than the market value of the home–this is compensated by the convenience of a lease option and the potential for appreciation on the price during the lease term–it’s best if you can get the price fixed at market value, and you should definitely not have to pay far more than the fair purchase price.
Beware lease options that lock you in to high-interest financing, and make sure you’re getting a reasonable amount of credit (in the form of option money) toward the purchase price.
It can be difficult to find a house the seller of which is willing to do a lease option, but don’t jump at the first (or any) chance that you get without fully understanding the terms of your agreement and making sure you’re getting a fair deal.
Keep in mind that unexpected changes in your financial situation, such as the loss of a job or a medical emergency, may prevent you from qualifying for a loan when you need it. The same can be said if interest rates rise during the lease term. A lease option is not without risk.
This entry is from Wikipedia, the leading user-contributed encyclopedia. It may not have been reviewed by professional editors (see full disclaimer)
I value putting the right deal together vs. simply pursuing a commission or fee.
The Manager, Tenant and Owner have to be willing to enter into forthright and honest business dealings.
There are Property/Owner situations, however rare, that have to be avoided and in the past I have actually returned properties when circumstances dictated.