A lease option is different from a lease purchase, in that a lease purchase binds both parties to the sale, whereas in a lease-option the buyer has the option but the seller does not.
1 Residential example
2 Reasons for using a lease option
3 See also
4 External links
The example below describes a typical lease-option for residential properties; commercial lease-options are typically more complicated.
The contract is typically between two parties: the tenant (also called the lessee or tenant-buyer), and the landlord (lessor), who owns or has the right to lease or dispose of the property.
In order to have a valid option the tenant-buyer must in most cases provide "valuable consideration" (a fee) for the option. Generally, sellers will ask for as much as possible--often around 3%-5% of the purchase price. The tenant-buyer usually will want to provide as little as possible--even a token amount of $100 represents "consideration." The option gives the tenant the right (but not the obligation) to purchase the property at a later date. The lease option only binds the seller to sell, it does not bind the buyer to buy. That makes it a "unilateral" or one-way agreement. In contrast, a lease-purchase is a bilateral, or two-way, agreement.
The basic elements of a lease-option are:
1. Buyer purchases the option. The parties agree to what the cost of the option is. As noted above, it can range from a token amount to 5% (or more) of the value of the property. The option fee usually is non-refundable. That is, if the tenant-buyer fails to exercise the option, the money remains with the seller. It is not refunded. The reason: The option fee is not a deposit. The option fee has been used to purchase something of value: the option.
2. The parties agree to a purchase price. It can be decided that the price will be the appraised value at the time the option is exercised. Generally, however, the purchase price is agreed upon at the inception of the option.
3. The length in residential real estate is typically 1-3 years. However, it is often unwise for the tenant-buyer to agree to a short period of time (often 2 years or less). The tenant-buyer often is expecting that the property will appreciate in value, particularly if the agreed-upon purchase price is equal to or higher than the fair market value at the time of the inception of the option. Perhaps even more important, often the tenant-buyer has credit or other financial issues preventing him/her from immediately purchasing. The option period is used to strengthen the tenant-buyer's credit, amass rent credits, and position him/herself to purchase. That often can take several years.
4. How much the monthly lease payment is, whether any of the lease payment is to be credited towards the purchase price reducing the purchase amount. Often, the monthly lease payment is equal to or slightly above the fair market rent of the property. And while it's fully negotiable, a credit in the range of 15%-25% is often offered. So, for example, if fair market rent for that unit would be $1,000, the seller might charge $1,100 with $200 of that being credited toward the purchase price.
5. Whether the tenant-buyer will occupy the property or whether the tenant/buyer has the right to sub lease or the right to sell the option. In most cases, the tenant-buyer occupies the property. Sellers will generally seek to make that one of the terms of the agreement.
Everything functions like a lease except there is a schedule when the buyer can decide to purchase the property.
The terms of the lease have to be negotiated also. These include items typically found in leases: maintenance, utilities, taxes, pets, how many occupants, insurance, ability to make modifications to the property, and so on. One note: Maintenance terms in a lease-option often differ from those in a standard lease. In a typical lease, often the owner is responsible for all repairs, except--sometimes--for a $50-$100 per incident deductible. Basically, the owner is responsible for virtually all repairs. In a lease-option, often a greater burden for repairs is shifted to the tenant-buyer.
During the term of the lease option, the tenant makes lease payments to the landlord for the use of the property with the terms mutually agreed. At the end of the contract, the tenant has the option to purchase the property outright. The tenant does so by going out and getting a mortgage.
Excess credit may also be applied towards the eventual purchase of the property, or towards the down payment for a mortgage..
NMLS # 6395
Financing Kentucky One Home at a Time
I answer questions about financing real estate based on my decades of experience dealing with mortgage underwriters. I do not offer legal or tax advice, if you need answers from an attorney or CPA find one knowledgeable in your local market.
Let me explain.
Too often lease/option appears to be an attractive alternative to those who feel they can not qualify for a home mortgage at this time. This option appears as a way to circumvent the protections in place for home buyers. To stray from beneath this umbrella of protection will expose you to extremely predatory practices. IN the end, you will not be made whole.
My advise would be to call a local real estate professional and discuss your situation. Based on your premiminary needs, you will be directed to the resources that will get you on the right path to acheiving your goals. It may take 6, 12, 18 months to become prepared and qualified. Don't be decieved. THERE ARE NO SHORTCUTS that benefit you.
Best of success,
Annette Lawrence, Broker/Associate
Remax Realtec Group
Palm Harbor, FL