Are you thinking about buying a home but don’t want to commit to a mortgage just yet? With the average cost of a house peaking just north of $400,000 in May 2022, it’s no wonder that you’re on the fence. But what if I told you that there are still deals aplenty to buy a house for the price of a car, even in this sizzling housing market?
At MY SMART COUSIN, we help aspiring property investors, and particularly Black and Brown folks and women, get into the home ownership and real estate investment game. As seasoned Real Estate Investment coaches, we help you find the right property, analyze and structure the deal, obtain free money as well as lender financing, and close on the transaction. We also help you discover the many channels where you can find a quality, low-priced homes, and invest as a homeowner, a buy and flip investor, or a buy and hold property owner.
One vehicle for financing properties is through a lease. I have never heard of a lease option agreement, also sometimes referred to as a rent-to-own agreement, don’t worry – you’re not alone. A lot of people don’t know about this powerful tool for acquiring and selling properties, but it can be a great way to get started in building a portfolio. In this post, we’ll explain what a lease option agreement is and how it works. Read on to learn more!
WHAT IS A LEASE OPTION AGREEMENT AND WHY SHOULD YOU USE IT?
A lease option agreement is a contract in which the renter has the option, but not the obligation, to purchase their rented property, either during or at the end of their lease term. There are many benefits to using a lease option agreement, especially for those looking to eventually purchase their own home, or as an alternative to the method of selling a property, you already own.
By entering into a lease option agreement, the renter can lock in the purchase price for the home and thus mitigate the risk that upon the purchase several years later, the future price is significantly higher. Additionally, a renter can qualify for a mortgage-type loan from the landlord in ways that their FICO score or financials might not allow them to. Lastly, lease option agreements often come with built-in flexibility, allowing the renter to choose a custom lease term length, typically ranging from two to five years. As a result, lease option agreements can be a great way to secure a future home purchase, buying into a neighborhood and home that you’re already familiar with and like.
HOW TO CREATE A LEASE OPTION AGREEMENT
A lease option agreement is a contract between a renter and a landlord that gives the tenant the right to purchase the property during or at the end of the lease term. The key terms of a lease option agreement include a non-refundable upfront payment which serves as an option fee giving the renter the right to purchase the home ahead of any other offers that the landlord might consider, and rental payments which often include an adder of $100 or more that is credited to the purchase price of the home should the renter choose to exercise their option to buy, the duration of the lease, property maintenance requirements— sometimes the renter pays some or all of the maintenance costs during the lease, and whether the tenant has the exclusive right to purchase the property.
– If the lease contract includes an added payment that can be credited towards the down payment to purchase the home, the renter should ensure that this payment is placed in an escrow account. Doing so can facilitate the refund of these funds, should the renter not purchase the home.
– If the purchase of the home at the end of the lease will occur through a balloon payment, the renter will need to ensure that they use the intervening lease period to get their credit score and finances in order so that they may qualify for a mortgage.
– The term of a lease option is typically two to five years. This time period provides comfort to both parties. It is long enough for many tenants to begin the process of qualifying for a mortgage, and short enough for property owners to feel secure in fixing the purchase price 2 – 5 years into the future without risking a substantial and unforecasted run-up in prices, leaving them with unearned profits
THE BENEFITS OF A LEASE OPTION AGREEMENT
Importantly, a lease option agreement is an arrangement between a landlord and tenant that gives the tenant the flexibility to purchase the property at a later date, usually at a pre-determined price. There are several benefits to this type of arrangement.
· First, the tenant may be able to pay, little by little, towards the eventual purchase price of their home while still renting it, through the added payment to the rent. This additional payment provides the tenant with a running start towards building equity in the home and can be used towards the down payment that a mortgage lender will look for when financing the purchase. Depending on how the contract language is written, the added payment may or may not be refundable if the tenant does not exercise their purchase option— renters will want to pay special attention to this section of the lease agreement, including hiring a lawyer or property investment advisor to assist.
· Second, the lease option agreement may give the tenant additional time to qualify for a mortgage. This can be beneficial for tenants who are self-employed, have poor credit, or face other challenges that make it difficult to obtain financing.
· Finally, the lease option agreement may give the lessee greater flexibility in terms of making changes to the property, such as adding new appliances or making cosmetic changes. This can be especially helpful if the tenant plans on exercising their option to buy the property.
WHAT TO DO IF THE TENANT DEFAULTS ON THE AGREEMENT
If you find yourself as a landlord with a situation in which the tenant stops paying their rent and thus is in default of the lease agreement, there are a few steps you can consider to try to recoup your losses and protect your property.
– First, you’ll want to send a notice to the tenant informing them that they are in default of their lease agreement. This notice should state how much rent is owed, give the tenant a specific date by which they need to catch up on payments and inform the tenant of any other defaults that are triggered by the late payment of rent, such as invalidating the tenant’s right to purchase the home at the pre-agreed price. It will be important to engage a lawyer at this stage rather than immediately begin the eviction process. A lease option agreement can be significantly more complex than a traditional rental lease agreement, and be subject to different legal requirements. At a minimum, a lawyer can draft a demand letter. This letter will outline the tenant’s legal obligations, and give the tenant a final chance to catch up on rent before facing legal action up to and including being evicted.
YOU CAN ALSO READ: WHAT HOMEBUYERS WANT: THE MOST IMPORTANT FEATURES
FOLLOW US: @MYSMARTCOUSIN