What is a lease option? Does it make sense to do it in this market? Who benefits – the landlord/seller or the tenant/buyer? Lease options have been around for many years, but they are becoming popular once again. Mainly because sellers are having a hard time selling their home with today’s bargain prices compared to what they owe the bank. A lot of buyers and tenants have bad credit due to the downturn in the economy, but still want to build equity through homeownership. So how does it work?
Basically, a lease option is two things: a lease and an option to buy the home being leased. Combined they make a nice opportunity for both buyers and sellers. In order for the lease option to work effectively, the tenant must put a substantial non-refundable deposit down of 3% to 10%. For example, say it’s a $300,000 house and the tenant puts 5% down. That’s $15,000 that could be lost if the buyer/tenant does not exercise their option to buy. This is the consideration which makes the contract binding and will also ease the seller’s worries that the tenant will up and leave. That would translate into lost time the seller could have been marketing his/her home to other potential buyers. The second part is the lease. The tenant and landlord will agree upon a monthly rental rate and they will agree upon how much of that rental rate should go towards the down payment in the home. For example, with a rental rate of $1,500 per month, $500 of that monthly rate could go towards the down payment of the home.
Lease options typically have a1-year expiration, meaning the home needs to be purchased outright 1 year from signing and the sales price is agreed to the same day the lease is signed. If it is not purchased, then the seller keeps all monies and the buyer just had an expensive lease for the last year! If the market goes down dramatically over the year, it may make sense for the buyer to walk away or try to renegotiate. And on the opposite side, if the market jumps up, the tenant/buyer will be very glad they locked in a low price one year ago.
In the above example, the tenant/buyer would have lived in the home for 1 year and put $15,000 down, plus built an additional $6,000 on the down payment ($500 of rent per month for 1 year towards the down payment). Using our example above, the purchase price would stay at $300,000 and the buyer would have to come to the table with only $279,000 to close. Another huge advantage to a lease option is often the tenant/buyer can show they have lived in the home for 1 year, making financing the property less expensive and easier, because they can show a track record. The buyer could also fix the home to their liking over the course of the last year.
Overall, lease options can be a great advantage to either a buyer or seller. Make sure it’s a fair deal for both parties and you’ll be surprised how creativity can be a great solution!