Have you ever heard of a “Lease Option” or also known as “Lease with the Option to Purchase”? I want to tell you the benefits of a Lease Option for both the Seller or Landlord and the Buyer or Tenant.
If you ask around, you will get opinions that are all over the place. Some people think they are great, and others think they are a scam. I want to give you all the information you need to form your own opinion.
I have used Lease Options for both my Fix and Flips and Rental properties. I have written articles on both topics. After you read this article on Lease with the Option to Purchase feel free to read my articles on Fix and Flips and Rentals.
- What is a Lease Option?
Again, a Lease Option and a Lease with the Option to Purchase is the same thing. A Lease Option is less complicated then you think. I will give you the definition and then explain it in more detail for you.
Definition – A Lease Option is a Lease Agreement with a specific term that has a Purchase Agreement written into it.
Now each one can be written up differently, so I am going to use the one I use as an example. Here is a link to the Investors section of my Resources page where you can find various materials you can use on your rental properties.
Term – On my Lease Options I like to use a term of 12 months. I have gone 24 months on some of them too.
Deposit – On a lease option there is a option price or deposit. This is typically 5-10% of the purchase price. The deposit is non-refundable and is credited towards the purchase price.
Principal Payments – The principal payments are in addition to the rent payments. For Example: If a home rents for $700 you and pay an additional $200 towards the purchase price making the monthly payments $900.
Purchase Price – This is negotiated at the time of the signing of the lease
Default – All money paid to Seller or Landlord is non-refundable if the term ends and the Buyer or Tenant does not purchase or is in default on rent payments.
Title Transfer – The title only transfers when the property closes. The Buyer/Tenant will need to come up with the funds to purchase, either cash or loan will work. The title company will need to complete all documents and handle the closing for the property to transfer. My Lease Option Agreement is written up that the Buyer/Tenant can purchase at any time during the Term of the Agreement.
- Benefits for the Seller on a Lease Option
There are many benefits for the seller on a lease option. I will share the three that make the most difference for the seller.
Higher Cash Flow – Because the Buyer/Tenant will be making extra payments to pay down the principal you will be getting more money monthly. Whether they buy the property or not you keep the money.
Higher Sale Price – You can usually get a better sale price because the buyer/tenant has less options and basically no negotiation power.
Higher Quality Tenants – Due to the cash needed for the down payment this will weed out the lower quality tenants automatically. Your tenants probably (But not guaranteed) be more responsible with your property and their finances because they have a good deal of money at stake.
- Benefits for the Buyer on a Lease Option
Just like there are many benefits for the seller there are also many benefits for the buyer/tenant.
Lock in a Sale Price – The market goes up and down and sometimes its good to lock in the sale price. Right now the prices keep climbing and you can secure a lower sale price now with a Lease Option.
Pay Down the Principal – You get the opportunity to use some of your monthly payments to lower the principal and be able to get a lower loan amount and lower mortgage payments.
Time to Work on Credit Issues – You may be considering entering a Lease Option because you can’t currently qualify for a loan at this time due to credit issues. If this is the case you can secure a property, lock in a price and start paying it down while you work on getting your credit score up.
To sum it all up, there are benefits to everyone involved in a Lease Option, but it is not always the best solution in every situation.
Some Landlords enter lease options with tenants they know will not be able to qualify for the loan before the term is up and therefore the tenant will lose all their extra payments and the down payment. The reason some (not that many, most landlords are good people) landlords do this is to produce extra income.
I suggest for any buyer/tenant thinking about entering a Lease with the Option to Purchase to speak with a lender before signing. They will be able to help you understand your current situation and give you advice on how to improve your credit. You can also find out if it will even be possible to be approved for a loan before the term is up.
If you own a rental property and you are thinking about going with the lease option make sure you fully understand how they work and if it is the best solution for your long term investment plan.
If you have any questions that I didn’t answer about lease options please leave me a comment bellow or send me an email.