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Originator Digest

A place for borrowers & Realtors to learn more than just the basics.

By Charles Dailey | Mortgage Broker
or Lender in Saint Paul, MN

Buying a Home on a Lease with Option to Purchase – Rent to Own

Since the housing crash and great recession, there have been swelling ranks of people that have had credit damaged but have increased their savings and reduced their consumer debt.  Many of these people, in a reasonable timeframe will qualify for conventional, VA, lease option to purchase.pngFHA, or Rural Development loans but at this time, do not.  For those who have their finances situated, saved money and increased their capacity to cover their housing payments, a Lease with Option to Purchase is a great choice.

A Lease with Option to Purchase is really two contracts that, by referencing each other in their respective agreements, constitute the entire agreement.  The “option to purchase” contract establishes the cost or consideration for the right to purchase the property at a later period; usually within a defined timeframe and also at a defined price or definable price (i.e. appraisal).  Part or all of the cost of the consideration for the option can be a credit to the “Lease Purchase Fund” (more on that later).  The “lease contract” contains the basics of a rental agreement (who, what, when, where and how much).  All other aspects of a proper real estate contract apply: (1) offer and acceptance, (2) consideration and (3) must be in writing (identify the parties, identify the property, purchase price, purpose must be legal in nature, all parties must be competent, all documents signed, there must be a meeting of the minds – everyone must understand the contract and their obligations within it).

Any tenant/buyer seeking to buy on a Lease with Option to Purchase should not do so lightly.  Many have been taken advantage of or gotten into something they thought was something else when they entered into this type of agreement without adequate professional assistance.  A tenant/buyer will need a competent Realtor or attorney who is versed in this type of contract.  They may want a good contact for credit repair to assist them in ensuring that their credit profile will be adequate for mortgage lending when the time comes to exercise their option to purchase.  Finally, they should consult a good mortgage loan officer who is versed in converting this kind of a contract into an executed purchase with institutional mortgage financing.  This loan officer should make clear what will be required for this exit strategy from the lease contract to exercising the purchase option.

At a minimum, your loan officer will need the following come time to execute the purchase:

  • A copy of the rental/purchase agreement evidencing a minimum original term of at least 12 months, clearly stating the monthly rental amount and specifying the terms of the lease.
  • Copies of the buyer’s canceled checks or money order receipts for the last 12 months evidencing the rental payments.
  • Market rent as determined by the subject property appraisal. (this will be done by a market rent analysis within the appraisal)

A tenant/buyer should know that the property seller may give the purchaser credit toward the down payment for a portion of previous rent payments the purchaser made under a documented rental purchase agreement that in an amount up to the difference between the market rent and the actual rent that was paid. These funds are a credit to the buyer aggregated in what is called a “Lease Purchase Fund.”  Consequently, the purchaser does not have to make a minimum cash down payment from his or her own funds in order for the rental payments to be credited toward the down payment.

So let’s say a tenant/buyer executes a Lease with Option to Purchase on a home and gives 10,000 dollars as consideration in an “option to purchase” contract with a price of 200,000 dollars inside of 24 month.  Let’s assume that ½ of the 10,000 will be a considered as rent paid if the option is successfully exercised.  The tenant/buyer also agrees to pay 2500 dollar a month in rent.  12 months later, the tenant becomes a buyer and executes his/her option.  During this process, the appraiser determines that the market rent is 1500 dollars a month.  The “Lease Purchase Fund” would then be constituted of the ½ of the 10,000 dollars plus the difference between the rent charged and the market rent as determined by the appraisal (1000x12+5000 dollars).  Thus the purchase price will be 200,000 dollars and the down payment from the “Lease Purchase Fund” will be 17,000 dollars or 8.5%.

For those who have means but are missing the credit profile at this time, the Lease with Option to Purchase can be a great means of taking advantage of today’s real estate marketplace.  But tread lightly and be sure you have quality professionals at your side.

Charles Dailey - iLoan - NMLS ID# 79048 - CA DOC, MN DOC & WI DFI - 612.234.7283

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