| Why Would Sellers Do A Lease Option? |
 |
 |
 |
| Written by Nick Johnson | |||
 A Lease Options is a "Rent To Own" arrangement, which is simply a lease where the tenant has the option to purchase the subject property. This tenant/buyer is sometimes called "Homeowners In Training" where they can own now and buy later.
With a Lease Option, you as a buyer can control a property without actually owning it yet. The "Lease" part of the agreement gives you the right to occupy the property and the "Option" part of the agreement gives you the right to buy. As part of the lease, a percentage of the rent payment is credited towards the purchase price. This means that you are occupying the property, the seller cannot resell it to someone else, and a portion of your monthly payment is going towards what is owed on your option to buy. Sellers will do a lease option for a couple of reasons. Sellers will do a lease option, mainly, for debt relief. When you "Lease Option" the property for the amount owed on the mortgage, you are giving the seller the debt relief they need. You are going take over the monthly payments, living in the house and maintaining it until you actually close the purchase of the house. Mean while, the seller now gets enough money from you to pay for their mortgage, taxes and insurance, and they no longer have to worry about maintaining the property. Also, some sellers may need to improve their "debt to income" ratio when buying a new home... A debt-burdened home-owner looking to buy new property has a slim chance of doing so. The reason being that mortgagees always examine your debt-to-income-ratio to determine how much you can pay towards the mortgage you take out for the new property. Now, you as a buyer, "Lease Option" the house from the seller. The lease payment the seller receives is considered to be income (for tax and credit score purposes) and this income offsets the debt of the monthly payment on the old home. Therefore, you are helping to correct the seller's debt ratio problem. When structured properly, Lease Option does not give rise to the due-on-sale clause; this may be a determining factor for the seller to do the deal. You as the buyer, probably, feel at ease about this too. The bank cannot call the loan due unless the title transfers. The title only transfers after you exercise your option to buy. Many due-on-sale clauses do state that the seller cannot give a lease to someone for more than a two to three year term. ‘Due on Sale' clause aims at restricting the seller from leasing out for over their term. To overcome this, create a Lease Option with a term of one year where the tenant/buyer has the right to renew for nine times. In essence, you would have a ten-year Lease Option that does not violate the due-on-sale clause.
You'll also want to consider doing a Lease Option if the due-on-sale clause is an issue for you and the seller. If the seller does not trust you or is concern the well being of their credit, they most likely will not deed you the property "Subject To" and leave it up to you to make the payments on the mortgage. If they deed you the house and you don't make the payments as you promised, it will hurt their credit score and not yours. This is where a Lease Option can be an alternative. With a lease option deal, you can keep it to live in, make it a permanent rental, sell it under a Lease Option, or retail it to a home buyer outright. Keeping the house for you to live in, retailing the house and making the house a rental, are all straight forward concepts. However, when you get into sub-leasing the property to another tenant with the option to buy, you need to understand may more details. What it simply means is that if you are the tenant, it gives you the option of becoming a home-owner of the very property you are renting. And if you are the seller, you have a buyer in place at a pre-agreed-upon price to be paid at a pre-agreed-upon date. Also, you get to collect a payment over and above the monthly lease. This money could be treated as security or down payment. You also have the assurance of your home being looked after by the tenant as if it is theirs. This is a situation very similar to Agreement for Deed or seller financing. The Agreement for Deed basically dictates that the seller has the right to the property's title and only releases it in the event of all the provisions being met. When you do a lease option, you are selling on flexible terms, which make it easier for the buyer to purchase the property. This creates value and the house is worth more because it has non-qualify seller financing than an identical house next door that requires you to qualify at a bank. Most appraisers fail to take into account financing when determining property value. Properties that are for lease with an option have a higher perceived value by the tenant/buyer because they are getting the opportunity to lease a property, build up a down payment, and have an opportunity to buy the property without having to qualify immediately.
When you Sub-Lease Option the property to a tenant/buyer, you can make money at three different times. You make money at the front end, the monthly cash flow, and the back end when the tenant/buyer refinances. Your first "profit" is the option fee you get from your tenant/buyer. This option fee is typically 3 to 5% of the agreed purchased price. This is a larger option fee from your tenant/buyer than what you gave the seller. Another "profit" is in the difference in the payment spread, rental income. When you Lease Option the property from the seller, you want to buy the property for what is owed on the mortgage (loan balance). When you sell the property, you'll want to get as much as you can relative to market value and demand. Typically, the rental payments on a house are more than what they are on a mortgage and of course, when selling, you're going to charge what the rent rate would be or even higher. You can also add an extra $100,150% or $200 (or a % of the rental income) that will be due in addition to the rent that is credited towards the tenant/buyers down payment. This money will be non refundable. So if the tenant/buyer fails to exercise their option for any reason, the extra money above the regular lease payment would be extra income. The other "profit" center is when your tenant/buyer exercises their option and buys the property, or what is called the back end. At that time, you'll collect the difference (equity spread) between your purchase price with the original seller and the sales price with your tenant/buyer.
|
Lease Option may not be the first choice in taking over a property. Taking a property under a "Subject To" and getting an Agreement For Deed give you a much higher level of control and ownership than a Lease Option does. However, the seller might be reluctant to deed you the property "Subject To", give you an Agreement For Deed, or give you a sales price so cheap that you can pay cash; this is when you offer your seller a Lease Option as alternative.
Tenant/Buyers who think like home buyers are more likely to take better care of your home, pay rent on time and fulfill other obligations, handle repairs and other maintenance, improve and upgrade your home, all of which makes land lording less painful. To screen "good" tenants, you need to have them fill out a detailed rental application; thoroughly check the tenant/buyer's credit history; make an unannounced visit to the tenant/buyer at their current residence... this is a preview of what your house will look like; call previous landlords to verify payment history, quality of tenants, etc; verify the tenant/buyer's employment history; ask for many references; get a large option deposit to create even more value in the tenant/buyer's mind, have the tenant/buyer responsible for maintenance (this is what they will be responsible for once they own the house), and you must use your instinct and common sense.