LEASE OPTION . . . EVERYONE NEEDS TO KNOW HOW IT WORKS
As home values continue to increase in value buyers can become increasingly anxious to purchase a home. Lacking the necessary down payment or the ability to proceed immediately, a “lease with option to purchase” can be viewed as a way to buy at today’s price, while having time to accumulate the necessary down payment to consummate a transaction.
A “lease with option to purchase” is an agreement between a seller and a buyer to sell a property for a specific dollar amount within a specified period of time, typically 12 to 18 months. The parties agree to a deposit (option amount) from the lessee (buyer), a monthly rent amount and any other concessions. Problems can occur if the agreements are not acceptable to a lender at the time the buyer decides to exercise his option to purchase.
While a seller must be highly motivated to enter a lease option, a good question to ask of the buyer is “what will be different in 12-18 months that will allow you to purchase then that prohibits you from purchasing right now? The answer to this question will determine if the parties should enter into a lease option agreement.
There are several considerations for both buyer and seller in a lease option.
- The seller may not contribute down payment funds or other cash to the buyer to facilitate the purchase. The seller may make some contributions as long as they meet lender guidelines (i.e.; paying a portion of the buyer’s closing costs, etc.)
- Since all moneys provided by the buyer for down payment, loan costs or cash reserves must be documented as acceptable sources of funds, determine at the very beginning of the transaction how this documentation will be accomplished. Cancelled checks, current bank statements or gift letters should be obtained immediately. Retain all documentation with the contract and deposit receipt. . .it is easier to obtain this data at the origination of the agreement than 12-18 months later.
- It is critical that everyone understands the “rent credit” portion of the contract. The only amount of the rent payment that can be credited toward the buyer’s eventual down payment funds is the portion which exceeds fair market rent. An appraiser will have to determine the “fair market rent” and the buyer may be required to supply cancelled checks verifying the actual rent payments made over the option period.
- Determining the purchase price can require compromise. While the buyer may prefer to “lock in” a price at today’s reduced value, the seller may expect values to increase and want to set a purchase price anticipating some appreciation during the option period. The final appraisal conducted when the option is exercised can cause confusion, particularly if market values have declined and the amount of loan the buyer can acquire is adversely affected. The alternative is that the property value may increase beyond the seller’s expectations and the seller develops “second thoughts” regarding selling.
- Buyers can be surprised that they must provide a non-refundable option payment, usually several thousand dollars, for the privilege of “holding” the property available during the option period. This money is forfeited if the buyer fails to exercise the lease option within the agreed upon time limit.
A lease option can be more complicated than it at first appears. Both buyer and seller should seek counsel from their Real Estate Licensee, their Mortgage lender and/or attorney.