Many people who are struggling to get mortgages are finding comfort in a growing trend: lease-options. This is a contract that allows renters to lease the property and, at the end of their lease, they have the option to buy the home.
Hopeful buyers with poor credit are finding the rent-to-own option creates an opportunity to repair their credit while positioning them for homeownership. It’s a win-win situation. Sellers find that properties that once sat vacant now offer cash flow.
The concept, while not new, is gaining momentum in today’s market.
There are a number of reasons buyers are finding this option appealing and it’s not just because of bad credit. Some buyers are not sure if they’re ready to own a home and take on all the responsibilities and extra costs that go with homeownership; the lease-purchase contract gives the buyers a chance to give homeownership a test drive.
Understanding the lease-option is very important. There are various differences in the way this type of contract can be drafted, so it is critical to hire experts to help negotiate the process to make sure you understand the terms and are protected. Here is some basic information about leasing with the option to buy a property.
Typically, in return for the landlord/seller extending the offer to buy the property after a period of time (usually one to three years) at a predetermined price, the tenant/buyer has to pay an upfront option (fee). That fee is generally non-refundable. A portion of the monthly rent may be applied toward the down payment to purchase the home.
Advantages for the buyer/tenant:
- Under this type of lease-option contract, for the period stated, you are the only one who has the option to buy the property.
- Typically a portion of your rent goes toward building equity and, when you purchase the home, is applied toward the down payment.
- You have a contract to buy the home when the lease is up.
- Usually you can buy the home at any time during the contract.
- You can see if home ownership is right for you by testing it out.
- In an appreciating market, you may get a good deal if the home goes up in value and you have already locked in a specific sale price for the home that is less than how much it appreciates. However, the reverse is true too. You could end up paying more for the home later on if it depreciates and a set price was locked in for a higher amount than what the home is worth when your lease-option is up.
- You have a chance to clean up your credit and build equity.
Advantages for the seller/landlord:
- Immediate cash flow from the tenant and the opportunity to sell your property later on.
- If the tenant/buyer doesn’t buy your property, you keep the upfront fee (option money).
- You may have a larger pool to market your home to because you are marketing to traditional buyers and also renters and investors.
- You will likely get higher-quality tenants who take better care of the home since the tenants may want to buy it in the future.
- Since you own the home, you retain tax-shelter benefits while you have tenants in the home.
- You may get some peace of mind knowing that you have tenants in your home who are working toward buying the home.
Things to consider when utilizing a lease-option/rent-to-own:
- Do a home inspection and document necessary repairs. Take photos to document the condition of the home.
- Make sure all payments are kept up such as mortgage, taxes, and insurance for the property.
- Verify if there are any liens against the property.
- Spell out the terms if the tenant/buyer does not exercise the option to buy the home at the end of the lease.
- Specify everything in writing; option contracts must have all the specific information that a sales contract would have in order to be enforceable.
- Prepare a draft of an undated and unsigned purchase agreement.
It’s always a good idea, when purchasing real estate, to contact experts to assist you through the process to ensure that you understand the contract and ultimately complete a successful transaction.