A lease option, sometimes called a lease purchase or rent to own is an agreement between a seller and a tenant-buyer which gives the tenant the ability to rent a home as well as the exclusive right to purchase it at a predetermined price sometime in the future. Lease options have many advantages for both the seller and buyer. I’ll talk about some of those benefits shortly, but first here are some of the mechanics of a lease option.
Upfront Option Consideration – In order to secure the exclusive right to purchase the lease option home, the tenant-buyer (optionee) will pay an upfront, non-refundable payment called ‘option consideration’. This option consideration is usually applied towards the purchase of the home if the optionee elects to buy. If the optionee does not purchase the property or otherwise defaults on the agreement, the option consideration is forfeited. Option consideration generally runs between 1-3% of the ultimate sales price of the home.
Additional Monthly Option Consideration – During the lease period, the tenant will make a monthly payment that will usually include a portion of the payment that will be applied to the purchase of the home. This additional monthly option consideration premium will help the tenant accumulate a large enough down payment to qualify for a mortgage in the future.
Term – The option term can be for however long or short that the seller and buyer agree. Usually this term will be between one and four years, but it can be shorter or longer depending on the length of time that the buyer would need to obtain permanent financing.
Purchase Price – The ultimate purchase price of the lease to own home is usually agreed upon at the start of the lease period. In some cases, the parties may agree to get an appraisal at the end of the lease term to determine the price, but this is less common.
Lease Option Benefits to the Tenant/Buyer
Gives time to work out financing challenges – The number one reason that a tenant-buyer will enter into a lease option agreement is to give them time to work out whatever challenges are keeping them from getting financing now. Whether it’s a low credit score, or lack of a sufficient down payment to get a loan, the tenant-buyer can use the lease period to get these challenges worked out.
Build equity while renting – There are few ways that the tenant/buyer can gain equity during the lease period. The portion of the monthly payment that applies towards the purchase is like paying down principal and reducing the amount that the buyer ultimately owes when the time comes to purchase. Also, since the purchase price is locked in, any improvements that are made to the house during the lease period build sweat equity in the home, and any general market appreciation during the lease period also favors the tenant. It’s the same benefits that an actual buyer would get, without having to qualify for financing now.
Make improvements to the property – Most lease option agreements will give the tenant/buyer the right to make improvements to the home. This gives the buyer a greater sense of ‘home ownership’ knowing that the work they put into the home can be captured as equity.
Limits Risk – Since the tenant/buyer has the right, but not the obligation to purchase, this gives them a great flexibility and ultimately lowers the risk of home ownership. If the tenant doesn’t want to purchase the home, they can simply move out at the end of the lease term. In this case, the option consideration is forfeited.
Lease Option Benefits to the Seller
Higher sales price – When marketing a home for sale as a lease opion, the seller can usually ask for a higher sales price because of the great terms that are offered to the tenant/buyer. Also, there is much less competition from other homes on the market, because there are relatively few lease option homes compared to the number of homes listed for outright sale. Also, often there is no real estate agent commission involved, which means that the seller can keep more of their equity as profit.
Better monthly cash flow – Payments for a lease option are usually higher than they are for a standard rental. That means that the seller benefits from a larger monthly cash flow.
Fewer landlord headaches – Lease option tenant-buyers tend to take better care of the property because they generally have a ‘ownership mentality’ and the non-refundable option consideration payment gives the tenant-buyer an incentive to pay on time.
Faster marketing times – Since lease options are in high demand, the seller can usually find a tenant-buyer in a fraction of the time that it may take to sell the normal way
The mutual benefits that lease option homes provide both the seller and buyer is the reason why they are popular. You’ll find many other resources on this website that will help you no matter which side of the transaction you are on.