The lease purchase is a neat and highly effective sales concept for many reasons.
One is the lease purchase is a way to get a pseudo homeowner into the property
before they actually buy the property. That's because the lease purchase
arrangement assumes the tenant will eventually buy the house. Because of this,
the lease purchase contract shifts much of the maintenance and repair
responsibility to the tenant. Even if the buyer doesn't eventually make the
purchase, they often keep the property in much better condition than a renter.
This can include the taxes and insurance on the property. Also, you don't get
the landlord calls in the middle of the night to unplug a toilet.

Lease Purchase - The Workings of the Contract

Buyers and sellers are free to write almost any clause they want to into a lease purchase agreement as long as they stay within their state laws. It's always a good idea to have a real estate attorney involved with your first several lease purchase agreements.

With a lease purchase, the seller and the future buyer typically agree on the future price of the house. One option is to set the price at today's market value with an inflation or market escalation clause tied to a reliable and specific index. It's common for the purchase price to be about 10% above market value.

Lease purchase offers the seller the highest sales price, a high option payment, the highest rent, and the least expenses. Lease purchase is the way to go.

The next major step in setting up a lease purchase agreement is establishing the cost of the option. Some sellers include the option price in the down payment if the buyer exercises the purchase option. Most don't. The option price in a lease purchase is substantial. This is how the buyer gets skin in the game and is a major motivator to completing the entire lease purchase.

Lease Purchase Benefits for the Buyer

The buyer in a lease purchase arrangement gets to 'test drive' the house, the neighborhood, and the school district. Depending how the contract is written, the buyer may have the price locked in for years in a rising market. This isn't a bad thing for the seller because the more value the buyer has in the property, the more motivated they become to complete the lease purchase process. If the market falls to far the buyer will walk away.

Although the option money doesn't usually apply towards the down payment, a portion of the rent normally does. This benefits both the buyer and the seller. In today's world, many people find it almost impossible to save money towards a down payment. Having part of the rent go towards the down payment is a way of forcing a buyer to make it happen. For the seller in a lease purchase, applying a portion of the rent towards the down payment is no big deal because the rent is set above market value. It's all upside for the seller. If the buyer doesn't execute the purchase, the seller keeps all of the above market rent. If the seller does go through with the lease purchase, the seller has sold the house at an above market price and collected the option money up front.

While technically the buyer is required to make the purchase in a lease purchase agreement, it's important for the seller to be reasonable. If the buyer walks away, it's likely because they can't afford to make the purchase or can't qualify for a loan. The seller may feel they want to compel the buyer to complete the purchase but it's probably unreasonable to do so. It's better to accept that you've made a bundle in option money and high rent and just start the lease purchase process over again with a new buyer and new option money.

Learn from my more than 20 years of experience in the real estate investing business including specialized lease purchase training at wendypatton.com.

If you're not familiar with the contract for deed house sale, it's also known as a land contract or land installment sale. You'll find minor variations to the contract for deed but generally it's an installment payment process where the seller holds the contract. With today's tough mortgage standards, the contract for deed is a good option for both the seller and the buyer.

A contract for deed enables the seller to obtain a better sales price and the buyer to become a homeowner when they can't qualify for a traditional mortgage. A draw back for the seller can be that it takes years to receive all of their money from the sale when they offer a contract for deed.

Contract for Deed - Structuring the Sale

Variations to contract for deed sales commonly occur in the terms and conditions of the contract. Rather than the boilerplate contract used by traditional lenders, almost anything can go into a contract for deed.

Contract for deed sales almost always have a balloon payment at a future date

The area of most interest to both seller and buyer is usually if and when a balloon payment becomes due. If the property is an investment property, the seller may offer to carry the contract for deed until the full purchase price is paid in 20 or 30 years. However, most sellers want their money sooner than that. A contract for deed may require the buyer to find alternative financing in as little as 2 years or it may be 10 years. Most contract for deed arrangements fall somewhere in between.

Circumstances of the buyer often have to be taken into account when determining the balloon payment of the contract for deed. If the buyer has a bankruptcy, the soonest they are likely to qualify for a traditional loan is not for at least seven years. Same thing for a foreclosure. However, a short sale might qualify in as little as two years.

Another issue of high interest to both the seller and buyer in a contract for deed is the interest rate. The seller is entitled to a higher interest rate than a traditional lender offers. With risk, comes reward. Buyers should expect to pay 8% and up as interest, although traditional rates are hovering at historical lows around 4%. This relatively high interest rate is something that can entice sellers to set the balloon payment farther in the future, so they collect the high interest rate for more time.

Contract for Deed - It's All in How the Contract is Written

Contract for deed arrangements favor the seller more than the buyer. As holder of the first mortgage, the seller retains the right to foreclose on the property if the buyer defaults. Unless the buyer completes the full terms of the contract they risk losing the property.

One thing the buyer is smart to insist be included in the contract is the requirement that the seller signed deed be held in escrow by a third party. This allows the deed to be recorded with the county in the event the seller cannot be found when the buyer completes their contract obligations. Also, the original deed for contract should be recorded with the county to put the world on notice that the buyer has an equity interest in the property.

An important clause for the seller to have included in the contract for deed is what happens if the buyer cannot obtain traditional financing when the balloon payment comes due. Laws vary from state to state but it can be difficult or impossible to foreclose on a buyer that is current with their payments but can't obtain a new loan required by the contract for deed. Besides, for most ethical investors, doing so would be morally wrong. The way most contract for deeds handle this is with a payment escalation clause. The interest rate can go up. Or the length on the mortgage can be shortened from 20 years to 15. Something changes when the balloon payment is missed to cause the buyer to pay more and motivate them to find traditional financing.

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