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All
about Lease Options
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Update
for 2021 Real Estate Market - When this web page
was created in approx. 2006, the information was all valid and
there were a lot of homes available to renters using a
lease-option. At this time, lease-option homes are virtually
non-existent in the market. The reason is that in the past,
many sellers were using a lease-option as a gimmick to try to
sell a home that was over-priced and hard to sell conventionally.
For sellers, there was little down side, as they either sold
the home over the market price, or picked up a huge deposit
when the tenant cold not get a loan on the property. The 2021
real estate market, with home prices rising to 15%, plus very
low inventory, meant that sellers did to need to use gimmicks
like lease-options or owner financing to sell their houses.
This is why Lease-options and owner-financing is virtually
non-existent in the current market. If you found this page in
the hopes of finding a home with a lease-option, I would
encourage you to skip any gimmicks to home ownership. Work
with a good lender instead and wait until you are truly ready
to buy a home. Read my reason for saying this here: The
trouble with lease-options
The information
below is for information purposes only, as there are virtually
no lease-option homes available anymore.
A
lease
option (also known as, lease to own, rent to
own, or rent to buy) is a combination of a conventional
lease, a purchase agreement, and an option contract to purchase
the property at a future date, usually at
pre-determined price. At the end of the lease term,
the tenant becomes the buyer,
and the landlord becomes the seller. Lease-options are typically used by home
sellers during periods of declining home prices or
slow sales. They are rarely offered during periods of
rising home prices or rapid sales, since sellers
benefit more from selling immediately. |
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| Benefits - A lease option
can have many benefits. In a perfect world, a
lease-option benefits both the buyer and the seller.
The tenant (buyer) is able to lock down a home and
perhaps put their financial house in order before
taking on the extra responsibilities of home
ownership. The tenant can also give the home a
"test drive" before deciding to purchase.
The landlord (seller) receives cash-flow from the home
during the lease period and a sale at or near market
price, at the end of the lease term. However,
lease-options can hold certain advantages or
disadvantages for each party (as I will discuss
below). |
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 |
Your goal
- Always remember
that your objective will be to purchase the home at
the end of the lease. Most lease-options are used by
people who do not qualify for a home purchase due to
poor credit, lack of funds, etc. If they do not change
their financial habits or manage to save enough money
during the term of the lease, they risk losing their
option money along with the purchasing credits of
their rent payments. If you have financial issues, you
should not enter into a lease-option contract unless
you can be reasonably certain that you will have
enough cash for a down payment and that you will be
able to qualify for a loan. To avoid surprises, always
consult with a qualified real estate professional and
a mortgage loan specialist before entering into a
lease-option contract. |
Some
important tips!
A
lease-option is suitable for someone who:
-
Has good credit
-
Has a property they are
selling and will have equity for a down payment
-
Has consulted with a lender
and is confident that they can qualify for financing at
the end of the lease term
-
Has a sufficient amount of
cash for the option deposit which is typically 1 to 5% of
the purchase price, and understands they may lose it if
they do not exercise the option.
A
lease-option is unsuitable for someone who:
Lease-option myths
-
The home owner will finance
the purchase - This is almost never the case. You
will most likely need to obtain your own financing at the
end of the lease term.
-
The lease term can be for
three years or more - Typically, the
term is 12 to 18 months, maximum
-
That all of the rent applies
to the purchase - Almost never. Typically only
a few hundred dollars per month is offered, and this is
usually only if the rent is increased to cover it!
-
A
lease-option or rent-to-own is a great way to build
"equity", vs. just paying rent -
Unfortunately, per the myth above, paying rent is all that
you are doing during the lease term. I have not found a
single instance of an option contract in which the seller
is crediting all of your rent money toward the
purchase.
-
That
it is a great
idea for people
with bad credit - This is very miss-leading!
It is very difficult to qualify for the lease and for
financing for the purchase if you have credit challenges.
Unless you plan to purchase the home will all cash, you
will need to obtain financing at the end of the lease
term, and doing so with poor credit will be very
difficult. I always recommend speaking with a lender before considering a lease-option, so that you can check your
loan qualifications.
Additional
pointers
-
Lease-option
terms are never published in the MLS. There are no fields
for lease-options in the MLS because they are done too
infrequently. It is strictly a phone call business between
agents.
-
Lease-options
are generally done by sellers who cannot sell their home
conventionally. In many cases, the true market value of
the home is below what the seller owes or below his equity
position. Therefore, they turn to a lease-option in hopes
of finding a tenant/buyer who will over pay for the
home.
-
Most
lease-options are never consummated and many tenants wind
up losing their lease-option deposit. This is usually due
to a lack of understanding of the risks and processes of
an option contract.
Basics of a
Lease-Option
-
The buyer pays the seller option
money called "Option Consideration" for the
right to later purchase the property. The lease option
money may be substantial and it is non-refundable if the
buyer does not exercise the option.
-
The buyer and seller may agree to a
purchase price now or the buyer may agree to pay market
value at the time the option is exercised. It is
negotiable. However, most buyers want to lock in the
future purchase price upon inception of the lease option.
-
During the term of the lease option,
the buyer agrees to lease the property from the seller for
a predetermined rental amount.
-
The term of the lease option
agreement is negotiable, but the common length is
generally from one year to three years.
-
The option consideration money
generally applies toward the toward the purchase of the
home.
-
A small portion of the monthly
rental payment also applies toward the purchase price.
-
Option money is rarely refundable.
-
Nobody else can buy the property
during the lease option period.
-
The buyer generally cannot assign
the lease option without seller approval.
-
If the buyer does not exercise the
lease option and purchase the property at the end of the
lease option, the option expires.
-
The buyer is not obligated to buy
the property at the end of the lease term.
Advantages and
disadvantages of Lease-Options
 |
Ideally, a
lease-option will be a "win-win", benefiting
both the buyer and the seller. However, there can be
certain advantages or disadvantages to each party,
depending on variables such as future real estate
market conditions, the tenant's financial situation,
etc. Here is a recap of the possible advantages or
disadvantages for the buyer and seller: |
Advantages for
the Tenant (Buyer)
-
It allows you to lock in a home of
your choice for future purchase
-
No one else may purchase the home
while you hold an option contract
-
It buys you time to get your
financial house in order (save for a down payment, repair
credit, etc)
-
You may gain additional equity if
the market value of the home increases during the lease period
-
You have the option to back out if
you find a better home, or if you cannot qualify for the
purchase
-
It's a form of savings - Some of
your rent payments may be applied toward the purchase of
the home
Disadvantages
for the Tenant (Buyer)
-
You will lose your option
money, plus the credit value of your rent payments if you
decide not to exercise the option
-
You may not qualify for a
loan if you have not improved your financial situation
during the lease period
-
The value of the home could decrease during the lease period, causing your purchase price to
exceed the fair market value
-
You are locked into one home
- You lose the flexibility to shop for and negotiate on
other homes
Advantages for a
Landlord (Seller)
-
The market value of the property may decrease during the lease period, rendering
your option price more valuable than current market value
-
You get to keep the option money if
the buyer decides not to buy the home
-
You get income during
the lease and a sale at the end of the lease
term
-
It allows you to lock a purchase
contract at a fixed price during a slow market
Disadvantages
for a Landlord (Seller)
-
The market value of the home may increase during the lease period, rendering your
option price less valuable than if you sold at current
market
-
The buyer might not exercise the purchase
option, forcing you to re-list the home for sale or lease
-
You cannot entertain other purchase offers
while a tenant holds a lease-option on the property
Lease-option
FAQ
What is the
difference between a lease-option and a lease-purchase?
A lease-option contract
offers you the choice of buying the home at the
end of the lease, while a lease-purchase agreement obligates you to buy the home. The risks also differ. Should you fail to
exercise a lease-option, you will lose only your option money,
but under a lease-purchase you would be in a breach of
contract since you are obligated to complete the purchase.
Lease-options can be beneficial to both buyers and sellers and
are popular in times of falling home prices or slow sales.
Lease-purchases are clearly a benefit to sellers but are far
riskier for buyers, therefore they are rarely done.
Return
to questions
Am I better off with a lease-option or just a
straight lease?
| It really
depends. In a lease-option, you'll need to ensure that
you are financially prepared for the purchase at the
end of the lease term. If in doubt, go with the straight
lease to avoid losing your option money. Also,
be sure that this is home you want to buy. If you are
new to the area or not sure about the home, you might
want to keep your options open and shop for other
homes while you're in a lease. On the other hand, if
you love the home and feel you will have the financial
wherewithal to purchase it, a lease-option is
a great way to go, since part of your rent goes toward
the purchase and no one else may buy the home while
you hold the contract. |
|
Return
to questions
Since a lease-option involves
certain risks, wouldn't it be wiser to start with a straight
lease and negotiate the home purchase afterward?
Possibly,
but there are certain risks to this approach also.
-
There is no
guarantee that you will able to purchase the home at the
end of the lease. The homeowner may decide to sell to you,
but he is also free to market the property to anyone and
to sell to the highest bidder, or, he may choose not to
sell at all. Under the terms of a lease-option, you hold
the exclusive right to purchase the property
if you qualify.
-
The homeowner is
under no obligation to apply any part of your rent toward
the purchase of the home, as he would be under a
lease-option agreement.
-
If the home
appreciates during the term of the lease, you could wind
up paying a higher price for the home than
you would have, had the price been "locked"
under a lease-option agreement.
Return
to questions
I would like to go with a lease-option. How can I
tell if I'm financially prepared?
Consult with a lender or
mortgage loan specialist. They will run your credit report,
review your income, savings, and assets, and discuss available
loan programs with you. If you are qualified, your loan
specialist may provide you with a pre-approval letter, which you can present as part of the lease-option application
package. On the other hand, there may be areas that require
improvement such as credit scores, reserves, etc. In this
case, you may want to work on getting your finances in order
before taking on the greater risk of a lease-option.
Return
to questions
Which contracts are required for a lease-option?
A lease-option requires three
contract forms: a lease contract, a residential purchase
contract, and an option contract, which defines all of the
option terms. Be sure to go over the details of each contract
carefully with your real estate professional, and do not be
afraid to ask questions! A lease-option is a big commitment,
so make sure it is the right choice for you!.
Return
to questions
What
are the various option terms?
-
The purchase price - Fixed price or market
price at the time of purchase
-
The amount of option consideration
money
-
The amount of monthly rent during the lease
period
-
The amount of rent credited toward the home
purchase
-
The length of the lease period
-
Closing costs
-
Termite and physical inspections
-
Appraisal considerations (what will happen if
the property fails to appraise for full purchase price)
-
Future appreciation or depreciation
-
Other terms requested by buyer or seller
Return to questions
What
is the typical amount of "option consideration"
money?
It can be as low as 1% to as
much as 5% or more, of the purchase price of the home. For
example, on a purchase price of $650,000, the lowest it would
usually be is $6,500, but it could be set at $10,000, $15,000,
or much more. The cost is set by the seller but it is
negotiable.
Return
to questions
Are
the option terms negotiable?
Yes, all of the terms are
negotiable between the buyer and seller. However, both parties
should ensure that they are represented by knowledgeable agents who will look out
for their best interests when drafting the agreement.
Return
to questions
What
if the value of the home decreases considerably by the time
the lease is up?
Move on! You might
forfeit your option money but a steep market decline will cost
you a lot more. If your purchase price is unrealistic, take
the loss and buy a different home at fair market value.
Return
to questions
What
if the home has appreciated substantially during the lease
term. Can the landlord back out of the deal?
|
As long as you signed a residential purchase
agreement, it's your gain if the current market value
exceeds the purchase price. The landlord could risk a
breach of contract lawsuit by failing to honor the
agreement - All the more reason to be sure to use a
qualified real estate professional to assist you.
Don't go it alone! |
Return
to questions
Are there other variations of a
lease-option?
A lease-purchase is similar to a lease-option, with the exception of the option
itself. The buyer leases the home for a specified period of
time and then is obligated to purchase the home at the
pre-determined price.
A lease with first right of purchase is a more informal
arrangement in which the tenant has the first right to
purchase the home at the end of the lease contract, but at
fair market value. There is no option consideration money and
no locked-in purchase price. The buyer and seller negotiate
the purchase price just before the lease term expires and if
they come to agreement, they go into escrow. If not, the
seller is free to re-market the property.
Return
to questions
Related links:
I hope this
article has answered some of your questions about
lease-options. Do you have a question that was not
addressed here? Please feel free to contact me! I will
be happy to assist you with a lease option or lease to
own property in Orange County, CA, as well as a sale,
purchase, lease, or rental. I will also put you in touch
with a loan specialist who can help you qualify for the
purchase. I am a real estate specialist in South Orange
County, California, including Aliso Viejo, Coto de Caza,
Dana Point, Dove Canyon, Rancho Santa Margarita, Mission
Viejo, Ladera Ranch, Las Flores, Rancho Cielo, Walden,
Wagon Wheel, Laguna Niguel, Robinson Ranch, Foothill
Ranch, Portola Hills, San Juan Capistrano, San Clemente,
or the Santiago Canyon areas (Modjeska, Silverado and
Trabuco Canyons).
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Copyright
© 2006.CDC Technology, Inc. All
rights reserved
No part of this article may be copied without
the express permission of the author, Ron Denhaan,
Realtor, Realty One
Group |
Bookmark this page |
The information herein was written by
Ron Denhaan, Realtor, Realty One Group and
represents the opinions of the author. It does not necessarily
reflect the views of other real estate agents, associations,
or of Realty One Group. While all of the
information is believed to be true, we do not warrant the
accuracy of the information. We cannot and do not warrant that
the information in this article is absolutely current,
although every effort is made to ensure that it is kept as
current as possible. This article pertains only to common real
estate practices in the State of California, USA. No part of
the article should be construed as representing actual legal
advice - Always consult appropriate professionals, such as
qualified attorneys, financial advisers, and real estate
brokers.. A lease-option may not be right for everyone. People
who cannot meet the financial requirements to complete the
home purchase should not enter into a lease-option contract
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