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The Real McCoy: How does a ‘lease option to buy’ work?

By: Kari McCoy, Special to Gold Country News Service
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Dear Kari,
My wife and I have been hearing a lot of talk about renting homes then buying them later down the road. Could you let us know if this is a good way to get into the home-buying business?

Answer:
This is a very popular question. A lease option is a written agreement that gives a renter an opportunity to purchase a property during or at the end of the rental time frame. To secure the contract option, money is necessary; usually 1 to 5 percent of the agreed to purchase price. When the time frame expires, the renter must exercise the right to purchase the home or forfeit the lease-option monies. Every situation is different and all items are negotiable. The option money is compensation to the owner for taking the property off the market and to agree to a future purchase price. If the tenant or buyer does not exercise the option to buy the property, then the option monies are forfeited to the homeowner or landlord. Typically the time frame is one to two years. A portion of the tenant’s monthly rent goes toward the purchase price of the home.
To be frank, most sellers accept lease options because their property is overpriced and most buyers seek lease options because they cannot get a loan.
Benefits that a lease option can offer to both parties.
• Attracts better tenants because they have money invested in the property and will most likely treat it more like their own home.
• Landlord receives higher rents and also a higher purchase price.
• Little or no maintenance costs to the landlord as it is understood in the contract that the tenant will be responsible for the upkeep and small repairs.
• Monthly income is generally considered to be rental income which benefits the landlord /homeowner with their taxes.
• Fast tenant removal and eviction process when default happens.
• Low deposit money for tenants. They do not have to come up with a large down payment.
• Tenants have an extended opportunity to get to know the house and the neighborhood before committing to buying it.
• Tenants benefit if the real estate market value increases.
• Landlord is least likely to have catastrophic damage from a person wanting to buy their home as opposed to a renter who has no real vested interest in the property.
• Landlords who offer lease options may attract more potential buyers.
Tips for creating a lease option.
• Keep the term as short as possible with everything in writing and signed by all parties involved.
• Landlord should pay taxes, insurance and homeowners dues if applicable.
• Tenant should pay for water and garbage with duplicate bills forwarded to the landlord.
• Landlord should take a separate security deposit besides the option money. This way if the tenant does not exercise the option there will be a money incentive to keep the property in good condition.
• Use separate agreements, one for the lease and one for the option money.
• Keep extensive records so as to protect both parties.
• Have an appraisal done on the property before drawing up the paperwork.
• The landlord should always practice full disclosure and have all tenants sign off on the disclosures.
• Take photos of the condition of the property before starting any paperwork.
• The contract should spell out the terms of the sale just like a regular purchase contract.
• Inspections and contingencies should be offered to the tenant.
• Keep the loan interest rate realistic and offer the tenant a fair amount of time for them to obtain pre-approval for their loan after the lease period expires.
It would be wise to have an attorney and or a Realtor involved in the transaction from an early onset to help benefit both parties.
Keep in mind if you work with a Realtor, he or she will not be paid unless the lease option is exercised and title transfers at the end of the term. If the lease option is set up correctly, the homeowner can make more money and the tenant benefits because he made a slow transition into becoming a proud new homeowner.
Kari McCoy owns the Kari McCoy Group, residential real estate at Lyon Real Estate. Email her at sold@
karimccoygroup.com