Lease Option

  1. Decide if a lease option is a good option for you. A lease option isn’t for everybody. If you need all the money from the sale of your home right away, you’re better off with a straight sale. In addition, the majority of lease options aren’t exercised, so you may have to begin the process of selling your home all over again after the lease term. You might also think twice about a lease option if you don’t want to, or aren’t able to, keep up with the responsibilities of continuing to own the home. In the lease option scenario, the owner must continue to pay property taxes and insurance and is generally still responsible for major repairs during the lease term.
  2. Place an ad. Many sellers are simply approached by buyers who want to do a lease option, but if you’re sure you want to go this route, you can place an ad in the paper or online. Ads for lease options typically receive a tremendous response, so you’ll likely have plenty of potential buyers to choose from.
  3. Do a background check on applicants. At this point, you have to look at potential buyers as potential tenants, and you don’t want to do a lease option with somebody who you wouldn’t rent to. Look for someone with good references, a steady source of income, and the ability to pay the rent plus, if applicable, the additional monthly option money. As far as the applicant’s credit history, you probably don’t want someone with serious credit trouble, but at the same time you may want to be somewhat lenient. Many buyers who choose lease options do so because they have some blemishes on their credit and want to improve their profile before applying for a loan.
  4. Pre-qualify your lessee. This step is often skipped, but it shouldn’t be. It’s a good idea to contact a loan officer or mortgage broker to at least discuss the potential buyer’s prospects for obtaining a mortgage at the end of the lease term. There is more uncertainty (and, hopefully, more chance of improvement) the longer the lease term, but both you and the potential buyer can get a realistic idea of whether they’ll be able to buy the house. This step is essential if it’s important to you to sell the house at the end of the lease, but ethically, and perhaps legally, it’s important regardless of your preference because if you take option money and above-market rent from a tenant who can’t possibly buy the house at the end of the lease, you’re just ripping the tenant off.
  5. Provide the potential buyer with a seller’s disclosure form. The disclosure form lists any known problems with the house. You attest, to the best of your knowledge, to the condition of the house. This form is standard for other purchase transactions but is sometimes left out in a lease option. Make sure you give the buyer this form to help him or her make an informed decision and to protect the integrity of the contract and sale. The buyer should also have an independent home inspection done.
  6. Negotiate a contract and collect option money. You can get fill-in-the-blank lease option forms online, but you’re better off getting them from a local real estate agent or attorney. The contract is sometimes added as an addendum to a standard sales contract. Unless you really know what you’re doing, get help with the details of the contract from an attorney or a real estate agent. The most important thing to remember is that you’ve got to cover not just the money issues but also who is responsible for what types of repairs and other complications that are bound to come up.
    • Agree on the purchase price of the home, which should be fixed on the lease contract. You’ll be obligated to sell at this price, so you want to make sure it’s something you can live with. Ideally, the agreed-upon price should be at least at fair market value and maybe slightly more (especially for lease terms of 1 year or more) to compensate for the convenience to the buyer and for the likely appreciation of the property over the term. You and/or the buyer may want to pay for an appraisal to validate the price. Banks and other lenders will only loan against the appraised value, regardless of the price that you agreed on with the buyer.
    • Determine how much option money to collect. Some states and municipalities have laws specifying a maximum amount of option money that can be taken, but in general the initial option money or option fee can be almost any amount. A typical figure is 2-4% of the purchase price. You will keep this money no matter what. If the lessee decides to buy, the money will be credited toward the down payment or the purchase price, and if the lessee doesn’t buy, he or she forfeits the option money to you. Keep in mind that many buyers choose lease options because they can’t come up with a big down payment, so don’t expect to be able to get a huge amount of initial option money.
    • Decide how much of the lessee’s monthly payment will be credited toward the option. Anywhere from 0-100% of the monthly payments can be credited toward the purchase price, although the amount is sometimes subject to state or local laws. In general, the monthly payment will be calculated at fair rental value plus a set amount that will go toward the purchase price. This, like the initial option money, will either be credited toward the down payment or the purchase price or, if the tenant doesn’t buy, will be forfeited to you.
    • Decide on the term of the lease. Lease options typically run anywhere from 6-24 months. Less than six months usually doesn’t make sense for the buyer, and more than 2 years (sometimes more than 1 year) may cause tax or legal complications. Shorter lease terms generally result in sales more than longer terms, simply because there are so many variables over the long term, but the length of the lease should be adequate to ensure that the lessee has time to get his or her financial ducks in a row. Keep in mind that if housing prices appreciate quickly, you may be getting a bad deal on a long lease, since you’re obligated to sell at the agreed-upon price. If housing prices decline, however, you may be getting a good deal, but if they’ve declined significantly, the lessee is unlikely to buy the house. You still get to keep the option money, however.
  7. Get the right insurance coverage. Since you will no longer be the owner-occupant of the house, you may need to update your homeowners insurance policy to a dwelling policy. Check with your insurance agent to determine what policy is necessary and what coverage you need. Your tenant should also be insured to cover his or her liability and, depending on your state, any gaps in your coverage that may result from the lease option.
  8. Collect monthly payments. Now, all you need to do is collect the payments each month. Keep track of the payments received so you’ll have a record when the time comes for the lessee to exercise the option (or, in the the worst-case scenario, when you have to go to court to settle a dispute).
  9. Sell the house. At the end of the term the lessee can exercise the option to buy the house for the price specified on or before the date specified. The total option money paid (including the initial option money plus any credit from the monthly payments) will go toward the down payment. Thus, the buyer already has equity in the home and should find it easier to get a loan.
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About PortlandHouseListings.com - Tom Ramsey, local Realtor

Local Portland Realtor with 10 years experience specializing in residential sales and investment property. Tom Ramsey Oregon Real Estate Principal Broker John L Scott Real Estate Phone: 503-481-0501 tomramsey1@gmail.com www.PortlandHouseListings.com
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