Can somebody clarify the lease option process?

Asked by Brad, Oregon Sat Feb 7, 2009

I'm confused about the lease option. I have a rental home and have had the same tenant in it for a number of years. They aren't in a situation where they would easily be able to come up with the down payment to purchase the home by regular sale, but I would like to help them do so if I could. So I have been trying to look into the lease option. What I have gathered is that I contract with them to a lease (as they have already been in) but with an option to buy the house at the end of a certain lease term. So, if they pay $1000/month in rent, they might pay $1000/month PLUS a lease option fee of $500/month for example. By the end of the pre-determined lease period they must exercise the Option. When they do so, any money they have paid can go towards their down payment? Is that correct? I have also read that the option funds don't go toward the down payment, but go towards lowering the agreed upon cost of the house. Are either of these correct? Thank you!

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Lana Lavenba…, Agent, Grants Pass, OR
Sat Feb 7, 2009
Either of thoser can be correct Brad - It all depends on what you and youlr tenant agree to. That is all a part of the contract you have drawn up. They usually suggest you have an attorney draw up the lease option agreement so that you have a regular contract. So like you said you can either have the money go towards their down payment or the cost of the house...The only thing is, for them getting a loan - the bank will want to see they have money down - so the money they are paying you, since they are a hard time coming up with a down - is to use it as the down payment - of course it all comes off the cost of the house that you agree upon in the long run. I hope that helps!
2 votes
Dp2, , Virginia
Sun Feb 8, 2009
A lease option is a compound transaction that consists of 3 separate transactions (and contracts): 1) the lease (ie your rental agreement), 2) an option to purchase the property at a certain price with the agreed upon terms, and 3) a purchase and sale agreement (provided your tenant/buyer exercises the option). Typically, the option fee is non-refundable, but it usually gets applied towards the purchase price if the option gets exercised. You'll collect your normal security deposit, first and last months rent, and monthly rent along with another fee (basically a portion of the down-payment--which you should escrow because this usually is refundable [by law in certain jurisdictions]). Make sure you document all of this, and it would probably be a good idea for you to hire an attorney to help you set all of this up.

So, let's use some numbers to help bring this home. Let's say you want to sell your house to your tenant buyer for 150K, and your tenant currently pays 1K/month rent. Let's also say you're willing to take a 5% down-payment (7.5K), and an option (to purchase the property at 150K using an all-inclusive trust deed [aka wrap or subject-to mortgage]) for 1K that has to be exercised within the next 12 months. Basically, that means your tenant/buyer will pay you 1K for the option, 1K/month for rent, and 625/month for the down-payment.

Make sure to redo your lease. You can keep most of your current terms the same, but you should have your lawyer to specify a clause to ensure that the tenant has to be in good standing with his/her rent in order to exercise the option.
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John C "John…, Agent, Grants Pass, OR
Sun Feb 8, 2009
Just like all other real estate transactions, no two are alike. The process varies from region to region, and depends a lot on the bargaining power of the parties. Here are a few variations on the lease option theme:

Tenant pays option money for an agreed price, rents the property for a time, with a portion of the rent applying to the price. The price is agreed in advance.

Tenant (optionee)leases the property, there is an escalator for the price (cost of living or changes in local values or other negotiated amount/rate). Some part of the rents may or may not apply toward the purchase price.

Owner gives an option in exchange for getting a tenant. Maybe there is option $$, maybe not. Maybe some of the rent applies, maybe not. It depends on the bargaining power and motivation (desperation) of the parties.

I have been a broker over 30 years, and I have rarely seen these work to a closing: If the tenant can qualify for a mortgage he generally buys now. It is not usually good from an owner's perspective; the property is off the market and tied up for the option period (the tenant gets the benefit of any price appreciation). Even though there is a contract, the tenant often leaves before the option period expires. I don't recommend them for owner/sellers unless there is a personal or family connection between the parties.

Things to consider if you are considering giving an option to buy your property: get $$$ up front to take the property off the market, any portion of the rent applying to the purchase price should be over and above what you could get from just a regular tenant. What else: late fees?, taxesand insurance?, repairs?, are any monies refundable?, credit/rental/criminal/ employment/income record?

If you are still inclined to provide an option on your property, take the agreement to your attorney (the optionee can pay the fee if you negotiate for it). Good Luck!
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Dallas Texas, Agent, Dallas, TN
Sat Feb 7, 2009
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Dirk Knudsen…, Agent, Hillsboro, OR
Sat Feb 7, 2009
Brad. This is a tricky one. If you charge them that option fee you need to set up an account in their name and hold that money in trust. It can not be commingled with the rent. The bank has to see that they have the money and that you are not just giving it to them.

Why is it a Lease Option when there is still some 100% loans out there? You can pay their closing fees anyway. So maybe make them a buyer this year with some of this possible stimulus money and benefits.

Get an attorney for a lease option if it involves them paying money over the rent and you holding it as a source of down payment.

best wishes;

Dirk Knudsen
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