What is a Lease Option and How It Could Help Your Clients

By
Real Estate Agent

What is a Lease Option and How It Could Help Your Clients

A lease option is an arrangement in which the lessor agrees to lease a house at a certain rate over a certain period of time. At some point, the lessor has the option to buy the home at a particular, pre-agreed-upon price.

If you’ve suffered at all in the recent housing crisis, you may, for credit reasons or financial reasons, be unable to qualify for a bank loan or afford the house you really want to move into. But there are options for this seemingly difficult situations. Especially if you’re looking to repair your credit. If this is you, then you may want to look into the possibilities of getting a lease-to-own or lease option deal on your house.

When you set up a lease option with a landlord, you agree upon a lease term and a set price for your monthly lease payment. However, somewhere in the contract there will be a stipulation that you have the option to buy the house, after a certain date, and at a certain price.

You’ll pay for that option, though—normally, your lease will be above what it otherwise would be in a standard lease situation. This extra money is often put towards a down payment on the house when and if you decide to buy. If, however, you elect not to buy the house—maybe the neighborhood was not to your liking—then the landlord will most likely keep that extra rent: it will be considered payment to the landlord for offering the option.

Most lease options are unique in that they are almost entirely configurable by the buyer or person receiving the lease, as well as by the seller or the person offering the lease. This means that any of the terms can change, and that you’ll have to do your own footwork to make sure that you get a good deal.

You’ll want to check rent or lease prices in the neighborhood for similar homes, as well as home prices. Compare these with what is offered by the loan company, so that you can make sure that you are getting a good deal.

If, on the other hand, you are a person who is trying to unload a house, or if you have a client who is trying to unload a house, then a lease option can be a great way to expand the base of people who can afford to purchase or have the credit to purchase your house. Even if they don’t buy the house, you get at least to make a good amount of money, just for offering the option to buy. Additionally, you can extend the offer to buy to people whose credit is insufficient to get a bank loan right about now.

There are plenty of resources out there than can help understand how to execute a lease with an option to buy for your clients. If you or a client of yours is interested in buying or selling a house using lease options, check out needtosellmyhousefast.com; they can help you structure the deal and find the right lessor or lessee for your house.

In my next post, I will be covering sandwich lease options, a great technique you can use to help homeowners in danger of foreclosure, while at the same time help people with bad credit purchase a house.

Comments (30)

Richard Weeks
Dallas, TX
REALTOR®, Broker

The Texas Real Estate prohibits Texas agents from handling this type transaction.  We are not allowed to incorporate lease to purchase language in either a sales or rental contact.  We must have an attorney prepare the lease option contract.

 

Mar 18, 2014 06:08 AM
Myrl Jeffcoat
GreatWest Realty - Sacramento, CA
Greater Sacramento Real Estate Agent

In the 32 years I've been licensed, I haven't ever done a lease-oftion/  I have however had several lease-purchases.  I like that with the later, some sort of performance is built in.

Mar 18, 2014 12:38 PM
Jill Sackler
Charles Rutenberg Realty Inc. 516-575-7500 - Long Beach, NY
LI South Shore Real Estate - Broker Associate

Thanks for the info. I've never had a lease with option to buy transaction before.

Mar 18, 2014 01:01 PM
Laura Cerrano
Feng Shui Manhattan Long Island - Locust Valley, NY
Certified Feng Shui Expert, Speaker & Researcher
Sometimes I've seen cases where people would want to house swap or housesit and be on the cheap believe it or not.
Mar 18, 2014 01:50 PM
John DL Arendsen
CREST "BACKYARD' HOMES, ON THE LEVEL General & Manufactured Home Contractor, TAG Real Estate Sales & Investments - Leucadia, CA
Crest Backyard Homes "ADU" dealer & RE Developer

They are under very tight scrutiny in the Manufactured Housing industry because of so many scams. I think it's just the tip of the iceberg on abolishing them once and for all.

Mar 18, 2014 11:51 PM
Dave Overholser
EXP Realty - Valrico, FL
Dave Overholser

Nice post...I've been specializing in lease options for 5 years and am still actively doing them.  Its a great niche to work and I would recommend anyone not doing them to look into doing them...just not in my area :)

Mar 18, 2014 11:51 PM
Michael Mullin
Caliber Home Loans NMLS 15622, Originating loans in CA, OR and WA. - Bend, OR
NMLS 11911 - Branch Manager, FHA, VA, USDA, Conv

Seems like the lease option is not a favored tool of this community.

A couple of the commentators have touched on my two biggest concerns from a lenders perspective, but I want to add a little detail.  

In our one last experience in helping a borrower execute their option, the transaction failed on both the rent credit and the price points. The transaction itself actually failed for somethign completely unrelated to the lease option terms.

First, as mentioned already, the monthly payment must be above "market rents" if the buyer is to be able to use it as a credit towards the down payment. Key is that it  must be verified by the lender's appraiser at the time the tenant executes the option. In our transaction the appraiser deemed the entire rent to be below market and NONE of the "rent credit" was allowed to be counted towards the down payment.

Second, the appraised value came in $10,000 less than the agreed upon price. The only reason the transaction went forward is because the seller was reasonable and agreed to accept the lower price.  The seller could have just as easily refused to negotiate and the tenant would have been out of a house and all of their option money. And that's how my first lease option client lost over $10,000 of their money.

I suppose there are transactions that make sense for both parties, but in my experience the lease options are usually just hiding some advantage one party (and it could be either) is trying to gain over the other.  In other words, in a "normal" situation a seller would just sell their property outright and a buyer would want to close immediately.  So lease options tend to involve an over priced home and/or an unqualified borrower.

Maybe Dave Overholser has some other suggestions for a successful lease option but I think at the minimum the tenant/future buyer needs to be screened by a lender (as much as is possible) so they know they can really buy within the time-frame allotted, the price needs to be agreed upon at a future date so it is actually within reason, and I'd not worry about trying to orchestrate a rent credit.  There's a good chance the lender won't allow the credit anyway.

Mar 19, 2014 12:27 AM
Lori Scardina
Keller Williams Realty Elite - Goodyear, AZ
Homes by Scardina

Thanks for the information/perspective - and all the comments. This has been a bit of a learning curve for me, as I have never been involved in one. Now I will have a little more information if it ever comes up.

Mar 19, 2014 12:39 AM
Ron Aguilar
Continental Mortgage - Saint George, UT
Mortgage & Real Estate Advisor since 1995

excellent post, thanks for your time

Mar 19, 2014 01:09 AM
Kathy Smiley
Rodeo Realty ~ Fine Estates Westlake Village - Westlake Village, CA
Westlake Village, CA - "Making YOU Smile!"

I have people ask me about lease options occasionally. The questions always come from someone who will not be in the position to buy for several years. We don't often have landlords or sellers willing to lease option, the hurdles are just too high.

Mar 19, 2014 01:12 AM
Hella M. Rothwell, Broker/Realtor®
Carmel by the Sea, CA
Rothwell Realty Inc. CA#01968433 Carmel-by-the-Sea
I have always wondered why anyone would agree to this type of sale. The future is so uncertain.
Mar 19, 2014 01:26 AM
Lloyd Binen
Certified Realty Services - Saratoga, CA
Silicon Valley Realtor since 1976; 408-373-4411

David, I saw this in the Daily Drop.  I haven't seen a successful lease-option for improved residential property in Silicon Valley since 1976, when I started selling RE.  My recommendation to buyers/sellers: get two contracts ratified:  (1) a binding purchase contract with an escrow duration for as long as the option period, and (2) a separate lease agreement for the duration of the option.   If the tenent doesn't exercise his option, he loses his deposit; it's the "option money".  And an "adjustable" sale price or rent applied to a down payment never works.  

Mar 19, 2014 02:22 AM
Dave Overholser
EXP Realty - Valrico, FL
Dave Overholser

They can be setup in different ways, the way I do them is the seller will set the price in advance, but he is aware that he can always go down in price he just can't go up...and I've never had a seller disagree with that and wasn't open to lowering the price if when the time comes the house doesn't appraise.  The option fee and rent credit when I set them don't go towards the down payment...i make them go towards the purchase price, that way its not something the seller has to set aside and just makes the whole process easier and less complicated.  For example, if the seller places the house for sale at 200k on a 2 year lease/option with a $300 a month rent credit and the tenant buyer puts 5k down at lease signing for the option fee and decides on the last month of their lease that they want to buy the house..they would deduct the 5k option fee and the $7200 in rent credits from the purchase price..so this would make the new purchase price 187,800.00 and this is what they would be buying the house for.  Now, if it doesn't appraise, the seller can always lower the price down to sell them the house.

As far as screening the tenants, they are screened just like a renter, most will all have some credit issues but the 2 year lease is used to give them time to get things cleared up and I give them some good resources for doing that so that they will be ready if they do decide to buy...one of the places is rentreporters.com which reports their rent payments to the credit bureaus, and they can even go back 3 years and put 3 years worth of verifiable rental history on their reports, which will give them a nice boost in their score by itself.  I go over with the owner all the details about the tenant and leave it completely up to them to whether they want to accept them or not...and of course both the tenant and seller know that the option fee or rent credits are refundable...so they either use it or lose it.

I don't know what percentage of tenants that actually go through and buy...I do know I have gotten the same homes back several times to do the lease option again...the sellers have been happy with the process and the tenants for the most part.  

Another thing, this is a great option for a seller that wants to sell but just doesn't quite have the equity to sell right now...so this will get him a possible buyer at his price and if the tenant doesn't buy after 2 years, thats ok...he can either do it all over again or put it up for sale then...it buys them time for their home to go back up in value.   I actually do this as a short sale alternative with some people, just depends on if they are behind and if so how much...if they are behind a few thousand I would just add that to the option fee and give that to them to get caught back up.   One last thing, as far as how I get paid, I collect the option fee or part of it at lease signing from the tenant, so it costs the seller nothing for my service but they do need to credit that towards the purchase price if they sell...hope this helps :)

Mar 19, 2014 03:04 AM
Jim Miner
Miner Noh & Associates - Phoenix, AZ
Loan Modfication & Short Sale Specialist

99% of the time the lease option is great for the landlord and a bag job for the tennant.  As the landlord I love them, I have yet to have a tenant excercise their option.

Mar 19, 2014 03:29 AM
Pamela Seley
West Coast Realty Division - Murrieta, CA
Residential Real Estate Agent serving SW RivCo CA

I recommended my short sale seller not take a lease-option with the new "seller" or who would become their "landlord" as they would be paying double for the home they just short sold. Not only that, short sale lenders do not approve borrowers staying in the home after short sale on a lease-back.

Mar 19, 2014 03:38 AM
Gene Riemenschneider
Home Point Real Estate - Brentwood, CA
Turning Houses into Homes

I don't see a lot of them around here.  I think the volitillity of the market is making them riskier.

Mar 19, 2014 03:54 AM
Kimo Jarrett
WikiWiki Realty - Huntington Beach, CA
Pro Lifestyle Solutions

With a reduced inventory, leasing/options are very few, however, it's always an option to secure cash flow.

Mar 19, 2014 06:24 PM
Linda De Fusco
The De Fusco TEAM Keller Williams Arizona Realty - Scottsdale, AZ
The Arizona Rainmaker

what is the difference between lease purchase and lease option. There used to be a differrnce. There isn't now?

Mar 19, 2014 07:50 PM
Robert Hicks
United Country River City Realty - Savannah, TN

Great info, interesting comments. Thanks for sharing....

Mar 19, 2014 09:55 PM
Jamie R. Bell
Bell Realty Group at Berkshire Hathaway HomeServices NEP - Glastonbury, CT
Your Central CT Realtor

This is definitely an option for the right buyer/seller combination. The terms are not necessarily going to give the tenant/buyer a good deal because they are asking the seller to take a risk on them.  Many times deposits become non-refundable if the buyer does not follow through with the purchase. And even the monthly lease amount may not be market value either. 

However, it can be a good option for the right parties. Good luck!

Mar 19, 2014 11:50 PM