10 Things to Know Before Signing Lease Option
Lease options (short for Lease with an Option/Right to buy a home) come to rescue! It used to be so easy to go out there and get a mortgage! But not anymore…due to recent housing crisis, economic slowdown, tightening of lending rules and regulations, to get a traditional mortgage has become a lot more difficult.
It is even more challenging to buy a house for those that have bad or no credit history, or those that work as a project-base contractor, self-employed or work for a temp agency on an assignment basis. Lease option or lease with the right to purchase is becoming more and more popular and accessible to help secure a property. A lot of the times lease options and rent to own agreements sound like synonymous and terms are used interchangeably. Although there are similarities, these arrangements are different but for our purposes we will treat them as same form of securing a property.
Lease Options Help To Secure A Home
Lease options give potential home owners that currently do not qualify for home mortgage an opportunity not only to secure a home but also to build and repair credit to be able to get a mortgage in the near future. Another great perk about entering in such a deal is that it gives you an opportunity to live there before you commit to buy a home.
Now let’s go over the basics of what a lease option is and discuss a couple of key things you want to negotiate with your landlord before signing the paper. Keep in mind, if you are dealing with a large company that buys homes and then rents them out with an option to buy, you almost have no negotiating power and have to accept what is proposed to you. However, if you are dealing with a private property owner, you have a lot more to leverage.
You should not treat this as advice or a lesson on contract law. Below are basic tips and things to look for when you are entering in a lease option agreement. You should always seek legal advice or hire an experienced real estate professional to assist you with the transaction.
Do proper research on the property you are leasing
Make sure property is owned by the party you are signing a contract with. There are way too many scammers and “investors wanna be” guys out there that arrange “sandwich lease options” that often times do not work out.
Outline the terms of you lease option!
Best piece of advice – don’t try to do it yourself, you will most likely screw up! Always make sure that all terms are clearly outlined and written on the contract, not a verbal agreement. Know for how many years you can rent a house before buying it. Is there an obligation to buy or just an option? Is there a down payment? Is it going towards purchase price or is that a fee? What are the payments, how they are being made and are there any rent credits that count towards purchase? Is any of it refundable? Make sure to spell out on the contract any personal property (if any) that seller/landlord is leaving for your use during this period until the transfer of title happens. What happens if personal property is damaged?
Is there a down payment!
Depending on what kind of a lease option or rent to own agreement you enter, down payment is usually going to be anywhere between 5%-20% of the sales price or there might not be any at all. Are you giving the seller this down payment as a “retainer” so he/she keeps the property off the market and does not sell it to someone else? Or is it a down payment towards the purchase price? Keep in mind that if a buyer backs out of the deal and decides not to exercise a contract then this down payment is usually non-refundable. If the seller breaches the contract and sells the home to someone else then it is refundable back to the buyer unless agreed otherwise but good luck getting it back.
Market Value Change
There are a number of reasons why one or the other will back out and this is actually a beauty of buying a rent to own property because it gives you a long time to think and it also give you an opportunity to change your mind unlike buying a home traditional way. Imagine a situation when you agree to exercise this option in 2 years and buy a home for $100,000.00 but the market acts goofy and the actual value goes down to $70,000.00. In this case you don’t really want to buy this home and can back out of the deal unless you renegotiate the price with the seller. Sure, you might lose your down payment and all the rental credits you paid but it is probably going to be less than $30,000.00 difference.
Now imagine a situation when you agreed to buy it for $100,000.00 in two years. Two years go by and now it’s worth $140,000.00. Of course, the seller won’t want to sell it to you when he/she can get $40,000.00 more. Unless you offer $40,000 more for it, the seller will most likely back out of the deal. To prevent yourself from losing your down payment and rental credits, make sure you talk this out and agree to it in writing with your seller before entering into a lease option agreement. If you have it in writing, you are in a win-win situation either way. You will get either an under-priced home or you will get a part of your down payment and rental credits back!
Determine your lease option monthly payment!
Figure out how much your monthly payment will be and how much will go towards the sales price as rental credit if any. This rental payment will build your equity in home before you even have a mortgage – how cool is that? This rental credit is usually going to be somewhere in 5-15% range of the monthly payment. So the total of rental credits at the end of your lease option term will be added to your initial down payment and will be applied towards the sales price. Remember: if you don’t buy a home when your lease expires – you lose your rental credits and your down payment. Know what you are getting yourself into.
Who pays seller’s mortgage bills?
Remember that your seller still has a mortgage on this house and someone needs to be paying it unless you are dealing with a large company or cash investor. This is very important because a lot of sellers have been collecting monthly payments but not paying their mortgage and such properties went to foreclosure. You want to avoid a foreclosure and you certainly don’t want to be wasting your time on a seller like that! So make sure that you are either getting copies of payment confirmations or make mortgage payment yourself and pay out the difference to the seller. Figure this out and agree to it in writing beforehand, don’t assume!
Agree with your seller on who is going to take care of the property in case pipes leak, plumbing goes to heck, electrical problems arise, roof starts leaking, basement flooding, etc…You need to know what to do when something goes wrong so you can act quick to fix the problem!
Get an appraisal or BPO
If you have a bad credit score, and can’t get a mortgage, it is easy to be side-blinded by the idea that you can buy a home now and forget to do the appraisal to know what this rent to own home is really worth. Usually, a seller will over price the house a little bit exactly for this reason. The seller has the power over the buyer because a lease option is not a very common way to finance homes. The seller knows that the buyer has no or very little options. As a buyer, be aware of it and get your appraisal first to know exactly how much you are overpaying and if it’s worth doing at all! Of course if you are just renting with no money down but have an option to buy or not, then no need to worry about it.
Protect yourself legally!
Have an attorney review your contract before you sign it, there is always something that you might have missed! It won’t cost much, but it will protect you in the long run!
Hire a real estate agent
Not every real estate agent knows about rent to own, lease options, and contract for deeds but some do and their knowledge and experience is very valuable. It usually doesn’t cost anything to use a buyer’s agent willing to help you because often times they are paid by the seller so why not have someone be there for you?
Do your homework, educate yourself, and don’t make mistakes!