Lease - Purchase. Good Deal or Bad?

With the slowing housing market, some sellers are leasing their homes with the option to purchase the home at a future date. So we ask, are Lease Options a good arrangement for sellers and buyers? It seems the answer is... it depends.

In a Lease Purchase Option, the seller leases their home to a tenant and gives the tenant the right to purchase the home at an agreed price, as long as the purchase is completed before the option expiration date. Typically, the tenant/future buyer will pay the seller an option to purchase fee, ranging from $1000-$10,000, when the contract is signed. The seller also credits a portion of the monthly rent, usually $100-$200/month, toward the future purchase.

The Sellers Side: The monthly rent pays down the mortgage. The upfront option fee is the sellers to keep. The tenant usually takes better care of a property they intend to buy versus one they are just renting. The monthly rental amount is higher than what the present market rental would be. The future selling price and the date the sale must be completed by is fixed at the time the contract is drawn. If house values decrease over the option period, the seller wins, if the purchase is finalized. If house prices increase during the option period, the buyer wins, if they buy. The seller can use the property as a rental, for tax purposes.

The Buyers Side: In a housing market that is appreciating, the buyer can lock in today's price for the property without actually buying it today. Buyers build equity because a portion of the monthly rent is credited against the purchase price. If the buyer does not purchase by the strike date, the seller keeps the rental credit and option fee. The buyer is able to live in the home before they buy it. The seller is responsible for repairs for as long as they own the home. The buyer has a period of time to put their finances in order so they can qualify for a loan. If home prices increase during the option period, the buyer has built in equity and may have an easier time obtaining financing.

Whether a lease purchase is a good deal depends on the circumstances and the future of the housing market. The reality for buyers and sellers is that 95% of the time, the buyer does not exercise their option to purchase. Usually, it's because they still can't qualify for a loan by the strike date. Unless the buyer is confident that their financial situation will improve in the next year or two, the option fee and excess rent are simply wasted money. Secondly, keep in mind that if home prices drop during the option period, the home may not appraise for the sales price, making borrowing more expensive, if not impossible.

Buyers, before entering into a lease option agreement, be realistic about the reason you can't buy now, and why that won't matter in the future. Don't option to buy a house you don't like. Negotiate for the longest option time period the seller will agree to. Have a home inspection before signing an option contract. Keep in mind that some sellers are scammers. They are betting on the fact that you will not qualify for a loan by the expiration and that they will keep your money and their property.

Sellers, be aware that most option buyers lack credit worthiness or they would buy instead of rent. In 95% of Lease Option contracts, the buyer will not complete the purchase. If home prices are declining in your area, you may be forced to sell for a lower price than you could sell for now. In addition, you may get the property returned to you in poor condition. Negotiate for the shortest option term the buyer will accept to lessen your risk. Keep an eye on your property and remember it's your house until the buyer closes.