The lease option and the lease-purchase somehow have a wide reputation of being mistaken for each other. This is traceable to some of the similarities they share. This includes the nonrefundable option and the restriction on landlords to not sell the house to anyone else.
Despite the overarching characteristics, they are distinct from each other. This exactly is the goal of this article: to help you understand both options and make informed choices depending on your circumstances.
Let’s get into it!
What Is a Lease-Option?
It is an agreement that allows a renter the choice to purchase a rented property during or at the end of the rental period. This agreement restricts the owner from selling the property to anyone else.
The expiration date for the term is usually between two to three years. When it expires, the renter either exercises the option or forfeits it. You can also describe a lease option as a lease with the option to purchase.
ℹ️ The 2 or 3 years duration is a common industry standard. It provides sufficient time for tenants to improve their score, save for down payment, or assess their comfort in taking up home ownership. Additionally, such a period is usually a reasonable timeframe for owners awaiting property value appreciation.
What Is a Lease-Purchase?
In real estate, a lease-purchase agreement is a contract between a renter and a landlord. The former is mandated to purchase the property at a later point in time. The tenant pays the landlord an option fee at an agreed-upon purchase price which gives them exclusive rights to buy the property.
Lease purchase agreements provide a specific duration of the lease, allowing the tenant to inhabit the property. The durations are established upon the signing of the contract.
Both parties agree to what the purchasing price of the home will be at the end of the lease term. The agreement will likely include a stipulation that a portion of the monthly rent goes toward a down payment. The renter should be confident that they can secure a mortgage at the end of the lease or else they forfeit the option to purchase.
Is a lease-purchase a good idea?
Lease-purchase agreements can be a good idea for buyers who are certain of their qualification for a mortgage, especially if they can reduce the lease to a shorter period of time.
This can also be a useful deal for those who are on track to improve their credit scores or those who need to wait until they have a longer employment history to qualify for a mortgage.
However, this does not eliminate the risks and expenses that come with lease-purchase agreements you probably wouldn’t have in a traditional home purchase.
According to Sarah Bolling Mancini, an attorney with the National Consumer Law Center, “A lot of times, rent-to-own doesn’t lead to purchasing a home.” “It can lead to losing wealth that you otherwise could have put toward the purchase of a home.”
For sellers, the agreement is likely to attract higher-quality tenants, who likely will also have an interest in maintaining the property. Many landlords collect above-market rent each month and potentially get a higher sale price when the buyer purchases the property.
What are the pros and cons of lease purchase and lease options?
Pros for the buyer
- Down payment: This is advantageous to the buyer because the tenant will finish the lease term with a sizable down payment saved by simply paying rent to the owner of the house. The agreed-upon rent is however likely to be higher than market value because of this same arrangement.
- Convenience: This saves the buyer the stress of searching and moving to another house entirely. Rather than move again, the tenant can offset the searching and moving expenses and stress by simply buying the home they’re in.
- Credit score: A lease-purchase/lease-option agreement can give the buyer ample time to boost their credit score or solve other credit problems while working towards homeownership. This is if the buyer doesn’t have a qualifying credit score for a mortgage.
- Build equity: In case the home value increases above the initially agreed upon purchasing price, the buyer has already built equity in the home and the house more valuable.
Pros for the landlord
- Large upfront payment: The property owner gets to keep the option fee even if the buyer doesn’t keep to their end of the buying agreement.
- Quality tenant attraction: Even if the owner is having a hard time finding a buyer, they can attract responsible tenants who are more likely to properly maintain the property through the lease-purchase/Lease-option agreement.
- Locked-in price: The owner has the exclusive power to choose the purchase price in advance. This can be good or bad depending on the housing market value fluctuations.
Cons for the landlord and buyer
- If the tenant decides to not buy the house after the lease period, the rent paid towards the down-payment is forfeited.
- Lease-purchase/Lease-Option agreement may not work for individuals with low credit scores. This will prevent them from getting a mortgage, especially if they have no plans for improving their score.
- If tenants under a rent-to-own agreement are late on their rent frequently, it can make them lose their monthly rent credit.
- These agreements can be risky for individuals with bankruptcies, foreclosures, and repossessions. This can harm your credit score and prevent you from qualifying for a loan.
How much should you pay for an option to buy?
It is important to understand all of the terms of the deal. This includes the length of the agreement and the amount of the option fee. This typically varies from a few hundred dollars to 20 percent of the value of the home.
Usually, you’ll pay above the current market price and a portion of your rent will go towards a future down payment on the property.
It is wise to also consider the counsel of a real estate attorney who has experience with these agreements to examine the contract before you sign it.
How do you get out of a lease-purchase agreement?
This is dependent on the clauses in the contract. Some clauses allow the seller or buyer to walk away without penalty while some don’t.
A buyer under a clause usually allows the seller to get out of the deal without legal consequences.
For instance, if the buyer can’t get financing approval by the sale date, the seller will walk away without penalty and keep the extra rent.
In a case where the home declines in value but the contract doesn’t provide a clause to allow the buyer to renegotiate prices, the buyer may back out and bear the loss.
Legal Aspects and Regulatory Requirements
Delving a little deeper, let’s explore some legal requirements for lease-option and lease-purchase contracts. Something you’ll likely encounter along your journey is the Secure and Fair Enforcement (SAFE) Act licensing requirement.
Picture this— you’re a property owner, wanting to offer a lease with an option to purchase, or directly sell your property through a lease-purchase agreement. Buckle up, because it’s more than a simple offer.
In some US states, you may need to have a mortgage loan originator license under the SAFE Act for these transactions… Simplified, this Act ensures that all parties within the transaction are protected and the rules of real estate game are fair.
Then you have the famous, or infamous, depending on who you ask – Dodd-Frank Law. This legislation, stemming from the 2008 financial crisis, established an array of regulations for financial institutions. Among these are specific rules for seller-financing, which includes lease-purchase agreements. The goal? To reduce predatory lending practices that hurt families and communities.
Next is the ‘Statute of Frauds‘— a compulsory player in any real estate transaction. It’s not an up-and-comer in the law world; in fact, it’s been around since the 17th century.
Simply stated, this dictates that certain agreements, including those related to real estate, must be in writing to be legally enforceable… The goal is to provide a clear written record of the deal to preempt any he-said-she-said drama.
Moving on, meet the ‘Recording Requirement‘. This rule instructs that certain documents (such as lease-option and lease-purchase agreements) need to be officially recorded in a county clerk’s office or similar local government records office. This act of recording doesn’t just give you that official stamp; it also preserves the terms of the agreement, ensuring that future title searches pull up accurate information.
A Recap of Rights and Safeguards for the Participants
- Buyer’s Right to Convert to a Deed: This pivotal right allows the leaser, or buyer, to convert their lease into an actual deed on the property. As if they’ve stepped into a home-buying time machine, they can switch their rented status to true homeownership, assuming they satisfy all agreement conditions.
- Prohibition of Forfeitures: A big win for leasers or potential buyers. This safeguard stops the lessor or seller from seizing the property if the buyer takes an unexpected detour from the agreement’s requirements. It’s like a safety net, ensuring you won’t fall flat if you miss a step on the property ownership trapeze. But remember, it doesn’t give you a free pass to ignore the agreement, it’s about fairness, not loopholes.
- Right of First Refusal (ROFR): Imagine someone offers to buy the property you’ve been leasing and dreaming of owning. The ROFR swoops in like a knight in shining armor, allowing you to match the offer and secure your castle before anyone else. Essentially, this right empowers you to hold the first ticket in line to purchase the property, maintaining your hopes for future ownership.
Practical and Financial Considerations
Before You Hop into an Agreement
- Money Matters: It’s vital to have a reality check on your financial management skills. If you’re not great at sticking to a budget, entering into either a lease-option or lease purchase agreement might end up doing more harm than good.
- Employment Solidity: Is your job secure or does your sector frequently experience ups and downs? If there’s any hint of job insecurity, think twice before tying yourself to a binding agreement that might strain your finances.
- Lifestyle Choices: Consider your future living plans. If you’re ready to put down roots, then a lease-purchase could be a decent fit. But if you enjoy the freedom to move around, you might find a lease-option agreement more suitable.
Understanding the Framework of Each Agreement
- Lease Option: This usually kickstarts with a rental contract between the landlord and the tenant. Attached to the rental agreement is an “option agreement”, giving the tenant the right to buy the property within a certain timeframe and at a locked in price.
- Lease Purchase: Contrarily, a lease-purchase contract mandates that the renter buys the property by the lease’s end date. This deal is less flexible and offers less wiggle room to change your mind.
Considerations Before Diving into a Lease-to-Own Agreement
- Appraise the Property: Consider more than just the asking price and financing options. Check the house’s current condition and its future value potential. Remember, you’re not just searching for a place to live; you’re making a substantial investment.
- Review the Agreement: Look over the lease carefully. What’s the duration of the lease? What are the default repercussions? Is an “option consideration” or an up-front payment needed? These matter in shaping the complete financial landscape you need to take into account.
- Solicit Legal Counsel: Lease-to-own agreements can be full of complexities. It’s wise to consult a real estate attorney before signing on the dotted line. They’ll ensure the contract meets state regulations, clarify any challenging legalese, and safeguard your rights throughout the agreement.
Summary
A Lease-Option/Lease-purchase agreement is clearly an investment strategy. The lease option gives more power and freedom to the buyer while the lease-purchase doesn’t.
Sellers are also usually forced into these agreements because of their inability to sell their properties at the time. Potential homebuyers can also use these agreements to their advantage, especially if they will be able to fulfill their end of the agreement.
So, to recap… both offer unique pathways to home ownership, but come with their own shares of benefits and pitfalls. The lease-option gives you a taste of living in the home before fully committing, while a lease-purchase agreement pushes you right into the buying process. These real estate avenues can be tricky, and like roots in a garden, the devil’s in the details.
Remember, no one approach suits all your financial situation, market conditions and personal needs will ultimately dictate the best option for you. Never be afraid to seek professional advice when needed. After all, a solid decision is only as good as the breadth of understanding backing it up.
So, explore, compare, analyze, and be sure. Good luck on your journey to home ownership!