LEASE OPTION . . . EVERYONE NEEDS TO
KNOW HOW IT WORKS
Updated: June 3, 2018
As home values continue to increase in value buyers can become increasingly
anxious to purchase a home. Lacking the necessary down payment or the ability
to proceed immediately, a "lease with option to
purchase" can be viewed as a way to buy at today's price, while having
time to accumulate the necessary down payment to consummate a transaction.
A "lease with option to purchase" is an agreement between a seller
and a buyer to sell a property for a specific dollar amount within a specified
period of time, typically 12 to 18 months. The parties agree to a deposit
(option amount) from the lessee (buyer), a monthly rent amount and any other
concessions. Problems can occur if the agreements are not acceptable to a
lender at the time the buyer decides to exercise his option to purchase.
While a seller must be highly motivated to enter a lease option, a good
question to ask of the buyer is "what will be different in 12-18 months
that will allow you to purchase then that prohibits you from purchasing right
now? The answer to this question will determine if the parties should enter
into a lease option agreement.
There are several considerations for both buyer and seller in a lease
1. The seller may not contribute down payment funds or other cash to the
buyer to facilitate the purchase. The seller may make some contributions as
long as they meet lender guidelines (i.e.; paying a portion of the buyer's
closing costs, etc.)
2. Since all moneys provided by the buyer for down payment, loan costs or
cash reserves must be documented as acceptable sources of funds, determine at
the very beginning of the transaction how this documentation will be
accomplished. Cancelled checks, current bank statements or gift letters should
be obtained immediately. Retain all documentation with the contract and deposit
receipt. . .it is easier to obtain this data at the
origination of the agreement than 12-18 months later.
3. It is critical that everyone understands the "rent credit"
portion of the contract. The only amount of the rent payment that can be
credited toward the buyer's eventual down payment funds is the portion which
exceeds fair market rent. An appraiser will have to determine the "fair
market rent" and the buyer may be required to supply cancelled checks
verifying the actual rent payments made over the option period.
4. Determining the purchase price can require compromise. While the buyer
may prefer to "lock in" a price at today's reduced value, the seller
may expect values to increase and want to set a purchase price anticipating
some appreciation during the option period. The final appraisal conducted when
the option is exercised can cause confusion, particularly if market values have
declined and the amount of loan the buyer can acquire is adversely affected.
The alternative is that the property value may increase beyond the seller's
expectations and the seller develops "second thoughts" regarding
5. Buyers can be surprised that they must provide a non-refundable option
payment, usually several thousand dollars, for the privilege of
"holding" the property available during the option period. This money
is forfeited if the buyer fails to exercise the lease option within the agreed
upon time limit.
A lease option can be more complicated than it at first appears. Both buyer
and seller should seek counsel from their Real Estate Licensee, their Mortgage
lender and/or attorney.
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