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A lease option more formally Lease With the Option to Purchase is a type of contract used in both residential and commercial real estate. In a lease-option, a property owner and tenant agree that, at the end of a specified rental period for a given property, the renter has the option of purchasing the property.
A lease option is different from a lease purchase contract , in that a lease purchase binds both parties to the sale, whereas in a lease-option the buyer has the option but the seller does not.
The example below describes a typical lease-option for residential properties; commercial lease-options are typically more complicated. The contract is typically between two parties: In order to have a valid option the tenant-buyer must in most cases provide "valuable consideration" a fee for the option. The lease option only binds the seller to sell, it does not bind the buyer to buy. That makes it a "unilateral" or one-way agreement.
In contrast, a lease-purchase is a bilateral, or two-way, agreement. Buyer purchases the option. The parties agree to what the cost of the option is.
The option fee usually is non-refundable. That is, if the tenant-buyer fails to exercise the option, the money remains with the seller. It is not refunded. The option fee is not a deposit. The option fee has been used to purchase something of value: The parties agree to a purchase price.
It can be decided that the price will be the appraised value at the time the option is exercised. Generally, however, the purchase price is agreed upon at the inception of the option. The length in residential real estate is typically years. However, it is often unwise for the tenant-buyer to agree to a short period of time often 2 years or less.
The tenant-buyer often is expecting that the property will appreciate in value, particularly if the agreed-upon purchase price is equal to or higher than the fair market value at the time of the inception of the option. That often can take several years. How much the monthly lease payment is, whether any of the lease payment is to be credited towards the purchase price reducing the purchase amount.
Often, the monthly lease payment is equal to or slightly above the fair market rent of the property. In most cases, the tenant-buyer occupies the property.
Sellers will generally seek to make that one of the terms of the agreement. An investor may acquire a distressed property with a lease option and make improvements to the property.
Then the investor can sell the option to a buyer that is willing to pay the new market value for a profit. It is a common financing technique with investors. However, it is riskier than other methods the investor could use for controlling the property.
The risks include the seller's inability to transfer clear title when the investor seeks to exercise the option. Seller has a property that needs considerable amount of work. Retail buyers typically cannot get financing or have too much to choose from to bother with physically distressed properties. This allows the buyer to NOT have to come with a large down payment and rehab money. Everything functions like a lease except there is a schedule when the buyer can decide to purchase the property.
The terms of the lease have to be negotiated also. These include items typically found in leases: Maintenance terms in a lease-option often differ from those in a standard lease.
Basically, the owner is responsible for virtually all repairs. In a lease-option, often a greater burden for repairs is shifted to the tenant-buyer.
During the term of the lease option, the tenant makes lease payments to the landlord for the use of the property with the terms mutually agreed. At the end of the contract, the tenant has the option to purchase the property outright. The tenant does so by going out and getting a mortgage. Excess credit may also be applied towards the eventual purchase of the property, or towards the down payment for a mortgage CAUTION, the buyer and seller can agree to whatever they want, but when the buyer goes to get permanent financing the bank has guidelines to what can be applied towards the down payment or the purchase.
Typically banks only allow an amount that is above and beyond market rent to be considered for a down payment. In that case, the lease-option works as an automatic savings plan for the tenant. This down payment is applied as part of the "option consideration fee"; in the arena of lease option purchasing this is a fee charged for the right to purchase the property.
Buyer is relocating and may need to sell a property in another area before the buyer can qualify to purchase the new home. Buyer is relocating and is unfamiliar with the new area. Buyer is seeking a VA loan and the property does not meet VA appraisal guidelines. Buyer agrees to make the needed repairs during the lease term to allow the property to meet these specifications. In the event of non-payment, it may be possible for the seller to remove the tenants through eviction, which is likely to be cheaper than foreclosure on a mortgaged property.
The lease-option may also require less money up front, while a mortgage might require a substantial down payment from the tenant. If the tenant does not exercise the option to purchase the property by the end of the lease, then generally any up front option money along with any monies that the tenant paid in addition to the market rental rate for this option may be retained by the owner depending on the agreement.
This might occur if the tenant no longer wishes to purchase the property, or if the tenant wishes to purchase the property but is unable to obtain the financing required to do so. A lease-option allows the seller to sell a property that they may not have otherwise been able to sell. In many cases a seller can net more money when offering terms to a buyer. Sellers can often avoid paying a Realtor fee by using a lease-option agreement as they have already found the buyer themselves.
For the buyer to get a favorable price the terms usually have to favor the seller. If the buyer defaults and the contracts are drafted properly then there is an automatic tenant landlord relationship.
All valuable considerations are typically surrendered and then it would be an eviction. Some forms of lease-option agreements have been criticized as predatory. For example, sometimes lease-options are offered to tenants who cannot realistically expect to ever exercise the option to purchase.
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