Apr 29, 2008

Is a Lease-Option a Good Idea?

I’ve had a few clients recently ask me about lease options and whether or not they are a good idea.

First of all, they are a bit misunderstood. It is not a risk-less way to get into a piece of property that you simply can’t afford now. Nor is it an absolute guarantee that entering into this arrangement will “land” you the property within a year or two.

You will find that many investor out there are willing to “buy the house for you and lease it back” while you save away enough for the down payment (when the purchase option is exercised). As an investor myself, I think this is wonderful. Someone pays the mortgage from me, I potentially benefit from appreciation, or at least I can theoretically use this arrangement to hedge against devaluation. Nice.

Is it the right thing for the Buyer? As a step of last resort, perhaps it is necessary. But if you can’t qualify for a standard loan in today’s market where rates are at a nearly all time low and FHA has jumped in to help, does that then say something about your financials to begin with? Are you ready for such a commitment?

Obviously it’s a case by case analysis and decision I would not make for a client family of mine. They would have to weigh the pros and cons (articulated with my help) for moving forward and make their own decision.

Here’s an article from the California Association of Realtors on Lease Options. One thing for sure… investigate wisely, as if you were going to be purchasing the home now.

Lease-Options are Back

A lease-option is utilized when a potential buyer wants to lease or rent the property with an option to buy it at a later date. The potential buyer pays separate consideration for the option to purchase at a later date to remain open for a specified period of time. If the potential buyers does not exercise the option, or does not purchase the property within the option time period, then the potential seller keeps the option consideration and retains the property.

Generally, lease-options are done in a slower real estate market when the reseller simply cannot sell the property outright. In this situation, a buyer, who may not have enough money for a down payment, can lease the property while they accumulate the money for a down payment. Often, a portion of the monthly payment by the potential buyer will go toward the down payment.

The option agreement must designate a price or state the price that will be determined by some objective standard when the option is exercised. Because the parties have entered into a binding agreement, the potential buyer may sue for specific performance on the option, requiring the potential seller to sell the property to the potential buyer under the terms of the agreement. The agreement must, therefore, contain all “material” terms for a purchase and sale to proceed.

Before proceeding with the lease-option, the potential buyer should consider:

a) Documenting the need for repairs with a property inspector

b) Checking for liens recorded against the property

c) Ensuring payment of the mortgage and taxed during the lease. Also, negotiating payment of insurance on the property

d) Ensuring that potential buyer will have the funds to make the down payment and qualify for any loan needed at the time of exercise of the option

e) Negotiating what will happen if the option period ends and potential buyer has not exercised the option.

f) Speaking with an attorney regarding removal of contingencies, disclosures, property inspections, etc.

After the lease-option is agreed upon, the option should be recorded to retain the potential buyer’s rights to the option.

Many thanks to CAR and Nicole Briggs for this article.

- Jim

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