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Frequently Asked Questions
There are many questions that people have asked me over the years about the two main ways to get into a home from a more creative perspective. These are mostly in the area of Lease Options.
What is a Lease Option?
A lease option is exactly what it sounds like. It is a lease (a.k.a. a rental) with an option to purchase at a future time.
Typically you will see between 3 – 10% of the purchase price for this option payment and it is usually paid before you take occupancy of the home. A price will be set for up to 2 or 3 years at which you must purchase or your option payment can be at risk.
To get a lot more details on how this works as a buyer read this in-depth Article on the subject, The Lease Option, A Buyer’s Perspective.
What is an “Option Payment”?
The option payment secures your right to buy a home. The amount is typically 3 – 5% of the purchase price of the home and is paid prior to taking possession of the home.
This payment is typically returned back to you when you buy as a Seller’s Concession. These monies will be applied towards the purchase of the home. This can be as part of your down payment, your closing costs, and then any remaining funds will go to reduce the purchase price.
This way you have as little out-of-pocket costs as possible when you decide to “exercise your option”.
What is a rent credit?
In a lease option, you will hear the term “rent credit” as one of the terms that are negotiated in a contract.
This “rent credit” is a credit that you get from each of your monthly rental payments. It will be credited toward the purchase of a home. Typically this may range from $100 to $500 or even more. Rent credits are based on the monthly rental payment and the desirability of the home. The higher the monthly base rent will often see a higher rental credit.
Just like the “option payment” this rent credit will be returned to you when you purchase the home as a Seller Concession. If you don’t purchase the rent credit may be forfeited to the landlord/seller.
How long can I do a lease option for?
The length of a lease option can vary. It depends on the needs of both the buyer and the seller.
A seller may want a short period of time or may desire a longer period depending on anything from monthly cash flow to tax reasons. If the seller just purchased the home he may want to do at least one year just due to short term capital gains tax reasons.
Typically, I see lease options go for two years.
The reason I see this is mainly due to the buyer.
When a buyer starts a new job or moves into a new town to start a new job the lending requirements dictate that they must be at the same or similar job for two years before being able to get financed.
If the buyer just had a Chapter 7 Bankruptcy then lending requirements state you must wait at least two years.
If you had a short sale recently then those lending requirements state that you must wait two years.
Thus, buyers often want 2 years or longer.
What if I don’t buy? What happens next?
If you are doing a lease option and you decide to either move out or not exercise your option then you will most likely lose both your option payment and the built-up monthly rental credits.
This is why you need to make sure that before you do a lease option that this is what you actually want t do. You must be motivated to actually buy the home in the future.
Can I do an extension for more time?
To do an extension on a lease option will depend on both the Buyer and Seller agreeing to the extension. There is usually nothing in a lease option contract which has automatic renewals. There are very good reasons for this.
One of the reasons is that nobody has a crystal ball to see what the future will do. In the 2 or so years that the contract is valid, there is no way of knowing what the rents will be at that time or even the value of the home.
The future price could have dropped or could have boomed. Also, the rental market could have gone up or down significantly in value.
When doing an extension all of the terms that were set previously will have to be addressed.
This includes is there going to be another option payment? Will the purchase price change? Will the rents be raised and, if so, will the rental credit be adjusted? How much more time will be added to the contract? And the last thing is what happens if you need another extension?
Should I buy now or wait?
That is always going to be a personal judgment call. All real estate markets fluctuate over time. Purchase prices will go up in a Seller’s market. Those same prices will go down in a Buyer’s market. This is also seen in the stock market where you have Bull and Bear cycles.
There are a few things you must consider when deciding if you should buy now or wait.
- What are prices doing right now and does it look like it will go up or not? Determining if we are in a Bull or Seller’s market means that prices are going up because there are typically fewer sellers than buyers. This occurs when inventory is low and there is a lot of demand for housing. In a Bear market or Buyer’s market means there is a lot of inventory and buyers can be a lot more selective. They also can offer less than what a seller is asking and many times will get the home under contract.
- What are the interest rates doing now and expect to do in the future? If interest rates go up even by 25 basis points (0.25%) will mean you will be paying more each month for the same dollar amount borrowed. Sometimes this will mean you will only qualify for a lower dollar amount of a home.
- If you are in it for the long haul then market fluctuations don’t really matter very much. If you plan on staying in a home 10 or more years then home prices typically will go up over larger stretches of time.
Other factors to consider are what are the rental rates doing in comparison to mortgage payments. If you could be paying less on a mortgage payment than a rental then you are actually saving money. The amount of principal reduction and the tax savings on the interest rates can be huge over time. Not to consider the pride of homeownership and other benefits of owning versus renting.
What happens when I am ready to buy?
In the lease option world when you are getting ready to purchase the home that you are already living we call that “exercising your option”.
In that case, you would go through the normal buying process. If I was the one who put you into the home then I would become your agent to aid with the buying process.
In most cases, unless otherwise agreed, the seller would be paying my commission.
The title company and your lender will work out the details of how much credit you have received and how that would be applied toward the purchase. As your REALTOR®, I will put together all of the paperwork that would be needed to complete this transaction.
How long is a typical lease option for?
The length of time for a lease option is mainly dependent on what your credit looks like or based on some other variables.
I typically do a 2 year lease option for a number of reasons.
Many lenders require a 2-year job history in order to get financing. Also, if you just had a short sale or foreclosure you may need to wait 2 years before you can buy again.
Many people who have credit issues of another matter may need at least one year in order to get their credit straightened out.
Who sets the purchase price? Is it negotiable?
In real estate, everything is negotiable, and this does include who sets the purchase price.
The purchase price is usually locked in for the duration of the contact. Thus, if you are doing a 2-year contract that will be the price during the entire contract. This is for both now and two years from now.
If a seller is selling a home traditionally and is offering a lease option you might see the price go up because of the option. This is typically to try and capture some expected appreciation, especially if you are in an appreciating market.
The final price will have to be agreed upon by all parties to have a contract in place.
Can the owner sell the home to someone else during my lease option?
The actual answer to that question is, “Yes”. The owner can still sell the home to another person.
A landlord can sell an occupied rental property to another person (think of it as an apartment complex). The only caveat is that the new owner still has to honor all agreements the seller has made to the occupants. This includes a lease option contract.
What are my chances that I will be successful in buying the home?
If you are going to buy the home (a.k.a., exercise your option) that will fully depend upon you and your actions.
The harsh truth is that less than 20% of the people who do a lease option actually purchase the home. All kinds of things can happen during the option period. Mainly life just happens.
The main reasons people don’t exercise is because they never worked on their credit. This is crucial when doing an option.