Working on Credit? Try Leasing with the Option to Buy
Of all the numerous ways of buying and selling real estate, leasing with an option to buy is one of the top ingenious home finance alternatives if you have low or no credit. Tenants who want to purchase but are not presently able to purchase, use it to secure a price against potential appreciation. It is also a means used by owners and property managers to entice worthy tenants. And it is used by owners of property that, for whatever cause, is not renting or selling at the price they desire.
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Leasing with an option to buy is precisely what it sounds like – a renting tenant signs a contract with a landlord affirming that the tenant may buy the property at the end of a prearranged time period. The owner is required to sell at the option price, but the tenant is not required to purchase. But when a lease-purchase exercised, the buyer is obligated to purchase at the end of the rental period.
A common misconception is that once a landlord signs this type of agreement, he/she must sell the property to the tenant, or that the tenant has an absolute right to the property. Not necessarily – the tenant may purchase the property only if the landlord exercises the option to sell.
There are a few pros and cons on both– property owners are in a secure position with a lease with option to buy contract than if they held a mortgage because they still have ownership of the property. Sellers also get rental income and receive income tax deductions. For buyers, the biggest draw is the simple fact that they get increased time to qualify for better mortgage financing.
Before one enters such an agreement, a written document has to be drawn up which lists out the terms of the contract prior to tenants moving in. Because the tenant and the seller are entering two distinct legal situations – a rental agreement and a contract to purchase – it is a good idea to have an attorney involved to make sure all bases are covered. But the purchase agreement is expected to state the price and distinctly define the terms. It is not a bad idea to add a condition portion that includes a monthly option fee and the part of the rent that will be applied toward the purchase of the home if the option becomes exercised.
The option should then be recorded with the county clerk to put others on notice of the rights of the tenant, which prevents the seller from selling to a different buyer. However, a seller that has financial issues during the lease term may not be able to provide the tenant good title whenever the option is exercised.
The lease agreement should have a clause that ceases the option to buy if the tenant in any shape or form violates the lease or gets evicted prior to closing the agreement to purchase. Some potential problems that should be addressed in the contract should include the following items:
Down payment: With your lease agreement, there should be a required. security deposit Since many states don’t allow these deposits to exceed one month’s rent, there could be an earnest money deposit requested to be kept in escrow until the option is exercised.
Purchase price: Generally, this is laid out in the original lease-option agreement – or in other words, the purchase price is determined according to the current market of today, not in the future when the option could be exercised. This is the potential good news/bad news, depending on how the real estate prices increase or decline during the lease. Another potential option is the “right of first refusal,” which means that the tenants can buy the property at a price set by the landlord at the time of sale instead of the time of the agreement. The tenant may additionally have the right to purchase the property at the price presented to the landlord by another potential buyer.
Legal title: An option to buy does not give the tenant legal title to the property. The tenant will become a purchaser only when the option is exercised, at which time the landlord-tenant relationship will cease and the option then becomes absolute and a binding contract of sale.
Rent credit: This is a distinctive lease-option feature. The tenant generally pays above-market rent on the property, but a percentage is credited toward the purchase price if the buyer opts to exercise the purchase option. For instance, on a house that rents for $1,500 per month with a 50 percent rent credit, about $750 per month goes toward the down payment at the time the option is exercised. However, if the tenant decides not to purchase the property, they do not get the rent credit money back. This is among the largest incentives for a tenant to purchase.
Due-on-sale clause: A due-on-sale clause may prevent the buyer from assuming the existing mortgage by allowing the bank to call the mortgage due when the real estate is sold. The terms of the contract of the seller’s mortgage and the lease agreement define whether the due-on-sale clause will be initiated by the lease with an option to buy. But, the lease with an option to buy can be a way of eluding the due-on-sale clause, pending the tenant exercising the option to purchase.
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