How Does a Lease Purchase Option Agreement Work?

Using a lease purchase option agreement to sell real estate can be a good choice for sellers who can afford to wait for full payment. This home buying option is sometimes used when buyers are engaged in credit repair, but cannot yet qualify for bank financing. In essence, lease options are a layaway plan that allows buyers to pay monthly installments for a predetermined amount of time.

A lease purchase option agreement can be structured to meet the needs of both buyers and sellers, but must abide by state laws. Most sellers require a down payment to secure the property for sale and contribute a portion of monthly rental payments toward the home purchase.

Lease option contracts should be executed by a real estate lawyer. The type of contract allowed varies by state and may involve a lease purchase agreement, options to purchase, or lease option.

Types of Lease Purchase Option Agreements

Lease options are the most common rent-to-own contract used. Buyers are required to provide ‘options’ money to secure the home for sale. The biggest disadvantage of option money is funds are non-refundable and do not apply toward the purchase price.

Sellers are prohibited from listing the property for sale when lease options are in place. Additionally, lease options contracts cannot be sold or assigned without approval from both parties. If tenants default on their contract, or cannot obtain bank financing when the contract expires, they forfeit all funds contributed toward the purchase.

Lease purchase agreements are the most intricate lease-to-own contract. Buyers are legally bound to purchase the real estate when the contract expires. If they default on the purchase agreement they could face legal consequences. Therefore, it is crucial to understand the risks involved before entering into lease purchase option contracts.

Buyers should conduct due diligence by obtaining real estate appraisals and home inspections. Buyers should obtain comparable sales reports to determine fair market value. Sellers can elect to lock-in the purchase price at the time lease purchase agreements are drafted, or require buyers to pay fair market value when the contract expires.

Buyers can provide a lump sum down payment or pay monthly installments. For example, the seller requires a $20,000 down payment, but allows the buyer to pay $5,000 upfront and extend the remaining $15,000 over the term of the contract. If the lease purchase agreement extends for 3 years, buyers would pay an additional $416.66 per month.

A portion of rent money is contributed toward the purchase price. Sellers rarely allocate 100-percent of rent money, but it can happen. On average, sellers set aside 10- to 40-percent of monthly rent. If the monthly rent is $1,200 and sellers contribute 40-percent, $480 is contributed toward the purchase price each month. Over 3 years, this amounts to $17,280.

Buyers with bad credit must engage in credit repair strategies to boost their credit scores and remove derogatory credit so they can qualify for a home mortgage loan when the lease option expires.

Lease purchase option agreements must be executed by a real estate lawyer and should include legalese regarding possession/occupancy rights and a default clause.

Options to purchase are similar to lease purchase agreements. Buyers provide a down payment and a portion of rent is allocated toward the property purchase. While sellers are prohibited from selling the property, they can sell the options to purchase contract to another buyer. If the contract changes hands, the contract terms are unaltered. The only change is tenants submit payments to the individual who purchased the options to purchase contract.

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