Real Estate Guide

Your Mortgage - Questions and Answers
'Lease Option Agreements'

• What is a lease option?
• What is the difference between a lease-option and a lease-purchase?
• What's the difference between a lease-option and a land contract?
• How do lease options work and what are the benefits?
• Where do I get information on lease options?

What is a lease option?

A lease option is a combination rental and sales agreement. A tenant signs a lease with an 'option' to purchase the property s(he) is renting for a specified price and within a specified time period. Usually the renter will 'buy' the option with an upfront down payment. If the renter chooses to exercise the option at the end of the term, the option money down payment is applied toward the purchase of the home, otherwise the seller keeps the option money and finds a new tenant. Additionally, in most lease-option situations, a portion of the rent being collected is applied to a future down payment on the home.

Lease options are most popular among buyers who don't have enough funds for a down payment and closing costs; and will be most popular during a slower real estate market when the seller finds it difficult to sell the home in the regular manner.

What is the difference between a lease-option and a lease-purchase?

Like the lease-option, the lease-purchase agreement is an alternative seller financing plan that combines a rental agreement and purchase contract. The main difference is that a lease-purchase obligates the tenant to purchase the property at the end of the lease. (With a lease-option the tenant has the right, but not the obligation, to exercise the option to purchase the property. See above.)

As with the lease-option, the tenant usually pays an above-market rent and receives a monthly rent credit toward the down payment at the end of the term, at which time the seller is obligated to sell the property on the terms specified in the lease-purchase agreement.

Most states, including Ohio, do not recognize the lease-purchase as distinct from a land installment contract and therefore, in case of dispute, would defer to the statutes governing land installment contracts.

See Also:  Alternative Forms of Financing.

What's the difference between a lease-option and a land contract?

See >>  Alternative Forms of Financing.

How do lease options work and what are the benefits?

A lease option is an arrangement with you and a seller to exercise the option to buy a house after you have rented it for a specific period. A portion of your rent would be applied toward the purchase if the option is exercised. This is referred to as rent credit, which most institutional lenders will accept as part of the down payment if rental payments exceed the market rent and if a valid lease-purchase agreement is in effect, a copy of which must be attached to the loan application.

If you are a seller, lease options can give you several advantages, especially in a slow market. These include:

1. A monthly rent higher than market rent
2. Top market value for the property
3. Tax-free use of the option consideration until the option expires or is exercised.
4. The renter is more likely to treat the property like an owner. Tenants who have a vested interest and believe they are a homeowner usually feel a "pride of ownership" that encourages them to pay on time, perform routine maintenance and even make improvements to your home.
5. Top sales price, even if demand is low:
6. Because you remain on the deed until the option is exercised, you maintain all of the tax benefits of ownership.

There are advantages for buyers too:

1. Equity can accumulate faster than with conventional financing through a bank or lender.
   • Rent money is working towards purchase.
   • Option money is credited towards purchase.
   • By the end of the lease-option term  there will frequently be little or nothing left to pay for a down payment at closing.
2.  Minimum cash out of pocket - usually only first and last month's rent and an option deposit.
   • You spend a small amount of money to control an expensive piece of real estate.
3. Any increase in property value will mean that your equity (what you owe minus what it's worth) is increasing in the home.
4. Your credit score will not be as important because you will be approved by the landlord/seller -  not a loan underwriter.
5. You will be put in full legal control of the home for a specified period of time without actually having to take title.
6. Before you actually buy the home, you will have the time the term of the agreement specifies to repair your credit, which was probably why you opted for the lease-option in the first place.

Read any lease-option arrangement carefully for details on transferring the option and other important concerns. If you do not expect your financial condition at the end of the lease-option term to have improved sufficiently to allow you to obtain conventional financing -  than a lease-option probably is not the right path to take.

See also >>

• The Benefits of Lease-Options by Matthew S. Chan
• How to Buy on Lease-Option
• How to Sell Your House on Lease-Option
• Lease Purchase Programs Come Of Age
• What you need to know about lease options (The Risks)

Where do I get information on lease options?

See >> Real Estate Guide: Resources - Lease Options