Buying a house using a Lease Option Agreement (also referred to as Rent with an Option to Buy, and in some cases, Rent to Own) is a great way to ease your way into home ownership and repair your credit at the same time.
A lease option involves a tenant-buyer leasing a house for a set period of time, usually 2 to 5 years. Additionally, there is an option to purchase the house during the lease term, for which a nonrefundable option consideration is paid at the beginning of the lease.
Following are 10 tips for the prospective for the Lease Option tenant-buyer:
- Locating the house: Finding a house that you like, can afford, and can negotiate a lease option agreement for may be one of the most challenging aspects of the entire process. There are several companies that specialize in these types of transactions who can assist you with the process.
- The Proposal: Make sure the home owner is open to the lease-option idea. The majority of home sellers put their houses on the market because they need the lump sum of cash to use for other purposes (sometimes to buy another home), so they can ill afford to accept a lease option offer. Keep in mind also that many homeowners have never heard of a lease option, and others are wary of them and really don't want a long-term relationship with their prospective buyers. Your best bet may be to enlist the negotiation skills of a lease option specialist to work with the seller to accept your lease option deal.
- Negotiating the terms: Here is where the lease option process may get tricky and the entire transaction could hang in the balance. The purchase price should be based on a realistic value for the property. Furthermore, your monthly payments should reflect your future mortgage payments, even if they are above current market rental rates. When you go to qualify for a loan, making those payments for two or more years will be a great history for you to show. Especially if your credit is challenged at the beginning of the lease.
- The Contract: Your contract in a lease option transaction should be prepared by the same professional manner as any real estate sales contract. Keep in mind that you're merging and option contract to a standard lease or rental agreement. When you decide to exercise your option, there will be a sales contract to execute. So it's a good idea to hire an attorney to prepare or review these documents.
- The property inspection report: If you intend to purchase a home outright, you may consider getting a professional engineer's report or the less expensive but shorter report from a home inspection company. In the case of a lease option transaction, a home inspection report will usually be enough to let you know what problems exist in the home and/or what repairs may be needed. This could also help in your negotiations with the home seller.
- The property condition: Many state laws and some mortgage appraisal guidelines require the seller to provide you with a seller's property disclosure attesting to the condition of the home. This disclosure, coupled with your home inspection report, is usually enough to apprise you of any structural damage or repair problems that could prevent you from obtaining a mortgage loan. In case such damage/repairs are found, make sure to negotiate that in your price and agree to remedy the condition during the lease option period. You can take your time and do this work, and by relieving the seller of the responsibility to do it, could help to solidify your deal.
- Building up equity: In addition to the negotiated price, you would pay a non-refundable option consideration for the right to purchase the house in the future at a predetermined price. This option consideration will go toward the purchase price. Furthermore, during the lease option term, whatever equity is built up through appreciation and mortgage pay down is yours to claim. Therefore, you should also willingly agree to do any repair work that may be required, because the work you do on what will become YOUR house (also considered sweat equity), adds to the overall value of the property and therefore translates into equity for you as the new owner.
- The Insurance Policy: Until you actually take ownership of the property you will be considered a tenant by insurance companies and therefore can only obtain a tenant's policy which will cover your personal possessions in the home. However, it may be possible that your interest in the property can still be protected via the home owner's policy or a specially devised policy depending on what area or jurisdiction the property is located in. Discuss this with your insurance broker or attorney.
- Recording the contract: Two to five years is a long time, during which many things can happen to affect the title of a piece of real estate. Having signed a contract does not in itself prevent others from making claims against the property you wish to buy. But by recording the lease option agreement, you will be letting the world know of your interest in the property, thereby averting the recording of any other instruments that could affect your equity/rights. You'll need a title company via your attorney to complete this step.
- The mortgage financing preparation: The mortgage application does not begin until a few months from the end of your option term. However, you would've had the full term of the option agreement to address any credit report blemishes, increase your earnings and put additional money aside for completing the purchase. One of the reasons prospective home owners opt of the lease option route is to have time to prepare.
A lease option transaction is an excellent method to purchase your first home or get out of a challenging credit situation and back into home ownership. Nevertheless, if you're looking to buy a home start working on improving your credit score today.
Jeff Sheiner is a real estate expert in assisting future home owners test drive their next home, no matter their current credit status. Go to www.EasyHousePurchase.com right now to learn more and get started.
