Today, the real estate market remains well poised for using a lease option contract to both buy and sell houses. Investors bring in more prospective buyers using the lease option contract and sellers lock in today's low selling prices.
Investors want to use a lease option contract to derive the highest possible income from their invests today, while bringing in a buyer for a future sale. The rental market has been hot for a couple of years with rents continuing to rise for the foreseeable future. Compound this with the fact that buyers can't qualify for a loan and you have the right mix to maximize your rent and help buyers qualify to buy in the future based on having equity in the house and a proven payment history. Opening the sale to a lease option contract brings in more potential buyers that drives the selling price to it's maximum.
Lease option contracts work for buyers for mostly the same reasons. They can't qualify for a loan today but they want to be homeowners nonetheless. A Lease option contract is about the only way buyers can lock in a low price today and begin the process of positioning themselves to qualify for a lease in the not too distant future.
Lease Option Contract - Tips for Avoiding Future Problems
Investors using a lease option contract several years ago probably remember that the lease contract and the option contract were written as a single contract. Live and learn. Today, more sophisticated investors are writing the lease and option contract as two separate documents. They are also being more careful with the terminology and phrasing of the documents.
The reason being is that based on a single document and the wrong phrasing, courts have interpreted some lease option contracts to give the buyer equity in the house. The legal process to remove a problem tenant becomes more of a time consuming and costly foreclosure process than an eviction or refusal to renew a lease. And you may have to return some money. For that reason, you must use two separate documents that combine to form the full lease option contract.
Words that you want to avoid are "credit", "seller" and "buyer". Especially in the lease document. Instead, use the standard terms "security deposit", "landlord", and "tenant". If the security deposit will be applied towards the down payment, you can make explain in detail, in the purchase option document, how it will apply only when the purchase option is executed. This should not be mentioned in the lease agreement.
Be clear in the purchase option document that the "potential buyer" receives no equity in the property until the purchase is fully completed. Getting this part wrong is were you run the risk of a court interpreting your lease option contract as converting the nonrefundable option fee into equity for the potential buyer.
The other goal of writing separate documents is capturing all agreements in writing by creating a detailed lease option contract. A clearly spelled out purchase option agreement also helps the potential buyer obtain a mortgage when the time comes. This happens when it's clear exactly how much equity in the property transfers to the buyer. A typical lease option contract transfers equity in several ways. The purchase option fee is credited as equity, part of the above market rent transfers as equity, and any appreciation in value of the property becomes equity. All combined this can be enough to qualify as the down payment to obtain the mortgage that both the seller and potential buyer want to happen.
Document the fair market rent at the time the lease option contract is signed. It can be difficult to document fair market rent after a few years have gone by. In addition to the fair market rent, be very specific how much of the above market rent becomes part of the down payment and any conditions that cause it not to apply.
Let's assume it's agreed that fair market rent is $800 per month and the above market rent being paid is $1,100. State that the difference of $300 will apply to the down payment only if the purchase option is executed. If the purchase option is not completed, the excess rent compensates the landlord for not being able to sell the property during the option period. The same thing applies to the nonrefundable option fee.
Make the agreement is all inclusive. If the above market rent does not apply in months that tenant is more than four days late with the payment, clearly spell that out in the lease option contract.
Other Lease Option Contract Tips
As the seller, use the lease option contract to motivate the potential buyer to move towards obtaining a mortgage. Set the option to expire in one year with the ability to renew it two times for a total of three years. The motivation is having a fee required each time it is renewed. Additionally, the longer the term, the more likely a court will view it more as a short-term mortgage than an option to buy.
Be clear that you are still the owner. You should have the taxes and insurance wrapped into the rent. But make sure you are the person paying them. Don't shift this responsibility to the tenant in the lease option contract. You can allow the tenant to pay the utilities if that is customary in your rental market. If it's customary for the landlord to pay, then make sure you do.
Be reasonable about the rent credit that applies towards the down payment. The more rent that is applied towards the down payment, the more courts see this as a build up of equity for the tenant.
Give the tenant a fair chance. Use a lease option contract that is fair and gives a reasonable tenant a chance to execute the purchase. It's easy for an investor to slip in lease option contract language that makes it almost impossible for the tenant to compete the purchase. If you don't want to sell the house, don't use a lease option contract. Be ethical.
Fully disclose all terms and conditions in the contract. Go over it in detail with the tenant before they sign. Encourage them to have their own attorney review it. Most attorneys will discourage a tenant for signing a lease option contract but a person determined to buy a house will sign with confidence as long as they clearly understand the terms and conditions they are agreeing to.
Besides reading this article about selling with a lease option contract, you'll want to read this other useful information that I offer free. Please take advantage of it today.
Several times each week, I make the most current real estate investing information available to readers. This time, it's about the lease option contract but the information I provide changes constantly to stay current with the market. Be sure to check back at: www.wendypatton.com. Also, get started learning how to do no cash option contracts by picking up a copy of my bestseller book: Investing in Real Estate with Lease Options and Subject to Deals.
By Wendy Patton
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