How Can I Buy Property with a Lease Option?

By Gina Pogol
Mortgage Credit Problems Columnist


Ben Asks: Dear Gina, I can't find home loans for people with bad credit anywhere. But I want to get a house while they are cheap. I was thinking about a lease option, but have no idea how to do one. How do I make this happen?

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Gina Says:

Dear Ben,

When you take on a lease option, the property owner leases the property to you with an option to buy the home in the future at a price you set today. In exchange, you pay money upfront for the option. This money is generally credited toward your down payment if you exercise the option. You may also pay a higher-than-market rent each month, with the excess being credited toward your down payment. This gives you time to take care of your bad credit, accumulate your down payment, and it locks in the price of your home.

Lease Option Pitfalls

"One important reality about lease options is that more often than not, the tenants never execute the option to purchase," said real estate attorney Diana Barlototta in a NuWire Investor article. If the tenant doesn't execute the option, "the investor walks away with that money" paid upfront and, depending on how the contract is written, the excess rent as well.

After a failed lease option, the investor can sell the property to another tenant and repeat the process. Many lease option courses actually teach investors how to set tenants up to fail so that they can't exercise the option and the owner can then re-sell the home.

Even if the seller isn't out to rip you off, the housing market could doom your purchase. In an environment where home prices are increasing, a lease option can be a great deal for the tenant/buyer. But when home prices are dropping, it can be a disaster.

What You Should Do

If you choose a lease option, take these precautions:

  1. Get an appraisal and inspection on the property. You don't want to be locked into a place that's overpriced or loaded with problems. It's well worth a few hundred dollars.
  2. Have a real estate attorney vet the contract. Make sure that the terms aren't too restrictive (like giving no grace period for late payments).
  3. Make sure that the contract states what the market rent is for the area and how much excess rent is credited toward the down payment (you need this to get your mortgage when you buy the property). You're better off paying no excess rent if you can force yourself to save that money every month on your own.
  4. Record and notarize the option. If your option was signed before a notary, you can record your option in the public real estate records. This gives the world public notice of your agreement.
  5. Escrow the deed. If your seller dies or disappears, you won't be able to get him to sign a deed. Have an attorney or title company create an escrow account upfront to hold the executed deed. When you are ready to exercise, you simply pay the money as agreed to the escrow agent and take the deed.

Most importantly, work to get your credit in shape so that you can qualify for financing. If you aren't very sure that you can do that, avoid a lease option. Instead, work on your credit and periodically check with lenders to see if you qualify to buy a home. You can do that easily right here on this site.

Sources

http://www.nuwireinvestor.com/ / http://www.mortgagenewsdaily.com

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