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Compelling Benefits Of Lease-Option Plans For Buyers
Don’t have the cash to fund a down payment to buy a property? A lease with an included option to purchase could be just what you need.
But before you pick up the phone now to call your real estate agent to make arrangements, you would want to learn a little bit more about the pros and cons of such agreement contracts.
What is a lease option?
A lease-option in property investing is like a combo platter in a seafood restaurant. It includes all the goodies like terms for sale, financing, rental, and of course, clauses.
Like a conventional tenancy agreement, it would state a specified period of time where the home will be rented to the tenant. And include terms stating a period of time whereby the tenant has the option to buy the property at a pre-agreed option price.
The time period where the buying option can be exercised by the option holder within a time-frame or at the end of a specified date.
It depends on what is agreed upon between the two parties.
The lease option route of buying real estate allows the buyer a quick and cheaper route to take control of the property while minimizing the risks associated with the investment.
There is little cash up front. Buyers can use cash flow to fund the property. They can also see how well the property market performs before committing to a purchase.
This can be a lifesaver if prices for real estate crashes before the buyer exercises the option to purchase.
Many sellers are happy to go this route. They don’t really care where the money is going to come from.
And having a buyer live in the house just makes them more likely to buy in the end. Because once a buyer starts settling down to the new surroundings the urge to stay put is going to be stronger than the urge to move again.
From an investor’s perspective, a lease option allows him to gain control over the property and decide at a later time whether to acquire the property outright in future.
And he can rent it to a tenant in the meantime to collect rental.
And if for example, the investor starts to accumulate as much as 10% equity in the property, he can technically obtain a proper mortgage to fund the purchase. Or even get a tenant to buy it from him!
Lease option vs lease purchase
Do not confuse a lease-option with a lease-purchase.
A lease-purchase is a bilateral agreement whereby the tenant is obligated to purchase the house, and the owner obligated to sell according to the terms in the agreement.
Whereas a lease-option allows the tenant to retain the authority of buying or let the option lapse.
Under both agreements, the seller is obligated to sell the property should a buyer decide to go ahead with the transaction.
Advantages of lease-options for buyers
The wide practice of lease options in the real estate industry shows that there are definitely benefits of it.
There is no down payment required
The only cash you have to cough out are the first month’s rental and the security deposit which is the usual industry practice for rental lease agreements.
But of course, if you are a shrewd negotiator, you might be able to slip your way through the cracks as well.
You might be asked for a small option fee until your make the security deposit payment.
A unique feature of lease-option plans is that a portion monthly rental paid by the buyer will be used as a credit towards the down payment for the purchase.
The portion of credit depends on the agreement between both parties.
Generally speaking, the higher the portion, the more painful it is for a tenant not to exercise a purchase option.
This is because by letting it lapse, the buyer will be forgoing the down payment credit that has been built up over time.
The buyer can take the house on a trial and live in it before buying. This allows him to see if he can get used to the surroundings.
The fear of not being able to adapt could be one of the reasons to go for these agreements in the first place.
By retaining the option not to buy, he can back out of the deal if he finds the house or neighbouhood unsuitable to his liking.
Gain control with little capital
A buyer will be able to control the property with little cash.
They can choose to live in it or even rent it out and use rental collected to repay the original seller.
How’s that for being crafty?
The best advantage is that the buyer gets to assess the property value in future while exercising a price that was agreed in the past.
This is great for appreciation players.
So if the agreed price was $500,000 and two years later the market value rises to $600,000, the decision to buy is really a no-brainer.
On the flip side, if property value is $400,000 two years later, the tenant-buyer can walk away or negotiate for better terms.
Why use lease options?
In such transactions, you can expect the seller to want to collect as much money as possible from the tenant-buyer in the shortest possible time.
The more the buyer has paid the more vested interest he has, and the more inevitable it is for the deal to go ahead as planned.
And if a buyer decides to back off from a purchase, the seller gets to keep all the money that has been paid.
This means that the opposite effect holds true for the buyer. He would want to pay as little as possible in as long a time-frame as he can stretch. The lesser he pays the smaller his investment capital.
And if the market indeed turns out for the worst, he will be thankful that he has minimized his losses.
As long as a tenant-buyer has not exercised the option to buy the house, there is always a risk that the seller tries to move it in the market or even tries to refinance it.
This can become a pretty messy affair if the seller-owner is insistent on doing things his way.
To protect your interest, please remember to get a proper attorney to go through your contract and lodge it with whichever authority in your state that will uphold and enforce the agreement.
This is so that any funny business that might come up before your purchase period expires will have to go through you.
This is the same for both a lease-option or a purchase-option.
Everything being equal, a lease option is always the better choice for a buyer compared to a purchase-option.
It must be one hell of a unique situation for one to prefer the latter.