The "Lease Option" Option. The "How To" of a Lease Option Program
Rent to Own How To
First, here's a no-nonsense definition. A Lease Option is a contract. Just like any other real estate contract, it’s an agreement between a buyer and a seller. However, during the lease period, to better describe the situation, let’s refer to the buyer as the "short term tenant," and the seller as the "short term landlord." The Tenant and the landlord. Hmmmm. Sounds a lot like renting, because during the lease period, it is in effect, a rental. One big difference. Within 12 or 24 months, that short term tenant turns into a real "buyer" and the short term landlord truly becomes the “seller.” Continued after the break.
So those are the key terms to remember. The Lease Option contract states that the tenant puts 3.5% to 5.5% down (this is typical but could be higher or lower) to secure the right to buy the home after the agreed-upon lease period. This down payment, we call it an "option fee," will be subtracted from the purchase price after the lease period, when the tenant buys the home. During the lease period, the short term tenant pays a monthly rental -- or lease payment. There are four major moving parts to the Lease option agreement: The option fee, the monthly Lease payment, the rental credit* and, ultimately, the purchase price.
#1: The Option Fee. As the tenant, he or she must pay for the right to fix the price of the home, and live in their future home for 12 to 24 months. The seller has a much stronger guarantee that the tenant will care for the home as any future owner of that home naturally would. The 12 – 24 month lease period is usually enough time to get credit repaired and regain the ability to go to the bank and get a mortgage.
#2: The monthly lease payment: This is, in effect, rent. But unlike regular rental agreements, this monthly payment buys peace of mind for the tenant and the landlord that at some point, a deal will be done. It's more than money changing hands. It's "good faith."
#3: *rental credit – This is optional, and not always part of every agreement, but part of the amount of the monthly lease payment can be credited towards the final purchase price of the home. A good perk if the tenant can get it, but not guaranteed in every Lease Option Agreement.
#4: the purchase price. At the end of the lease period, the home is sold in a fairly conventional manner, with the option fee subtracted form the purchase price, so the formula is: Initial price minus the option fee = the purchase price.
Before the "Lease option option" is considered, the tenant/buyer has some qualifications to meet. They must be able to pay the option fee up front, and typically they're asked for one month's rent security deposit, and most importantly, they must produce evidence from a qualified mortgage counselor or credit repair company that their weak credit situation is indeed temporary – and require no more than 24 months to repair.
Continue to follow our Bloom Realty Blog series about the Lease Option/Rent to Own approach to getting into the home you love.