In this issue:Lease Purchase Full of Pittfalls
In a lease purchase, in most cases, you will rent at a higher cost than the going market rate. Prior to moving in, you agree on a potential purchase date and purchase price for the home. You may buy the property at any point during the rental period up until the lease option expires, providing the allowance to do is spelled out clearly in your agreement. The lease option period can be any length of time that you and the seller agree to, ranging from several months to several years.
If you do end up buying the property, the seller will usually credit part of your rent back to you, often-times the portion of your rent that was above market rate. You can opt to put this money toward a down payment and closing costs, or keep it. The purpose of the above-market rent is to give the seller an incentive to complete the transaction. If you do not purchase the property, all of the rent you paid remains with the seller, giving the seller an incentive for taking the property off the market during the time you were renting it.
How a Lease Purchase Benefits Sellers
A lease purchase favors the seller if he or she is having a hard time selling their property. The rent-to-own option provides the seller with an alternative to lowering the price, taking the home off the market, or renting the home long-term. In the meantime, the lease purchase helps the seller pay the mortgage, property taxes and insurance. Unlike a traditional rental, tenants are more likely to take special care of the property because they hope to own it at the end of the lease purchase time period.
How a Lease Purchase Benefits Buyers
The biggest advantage a buyer would have with a lease purchase is financial, of course. If buyers don't have the down payment saved or adequate monthly income to qualify for a mortgage but believe they will within the next couple of years, a lease option allows them to accelerate the path to homeownership. By signing a contract now, the buyer locks in a purchase price, which means no worrying about rising home prices.
Also, a seller will usually continue to pay the property taxes, insurance and maintenance and repairs on the property. And by living in the home, the buyer gets a lengthy test drive before diving into the financial commitment of owning the home themselves.
Best of all, if the buyer decides to walk away from the deal, the only real consequence is the loss of that portion of rent paid that was above market rate. If the buyer ends up buying the property, the seller will credit part of the rent back to the buyer, often more than the portion of rent that was above market rate.
Lease Purchase Full of Risks For The Buyer
A would-be buyer should be aware of the many things that can go wrong in the process before getting involved in a lease purchase agreement. Before entering a rent-to-own agreement, a potential buyer should:
Check the seller's credit report. - Look for potential warning signs that the seller may be in financial trouble, such as delinquent accounts or a large amount of outstanding debt. Even after a satisfactory credit check, a potential buyer who currently lives in the home should still pay attention to any warning signs that would indicate that the seller is in financial distress. Some examples include phone calls from debt collectors and suspicious-looking notices that are sent to the house.
Understand that the seller could lose the property during the rental period. - This could occur for any number of reasons such as if he or she is unable to make the mortgage payments, a tax judgment is placed on the property, he or she goes through a divorce, is being sued, etc. If the seller loses the property, the potential buyer loses the possibility of buying the property, forfeits the extra rent paid and will have to find a new place to live. There is one possible exception: if the home becomes bank-owned through foreclosure, the bank might consider selling the home as soon as possible to the lease purchase buyer in order to avoid the hassle of maintaining and marketing the property to a different buyer. In this case, the rent-to-own buyer would have to decide whether the purchase is feasible at the new date, and possible new terms of purchase.
Ensure that the lease purchase option clearly states who is responsible for maintenance or repairs. - This agreement should also specify the types of changes or improvements (if any) the potential buyer is allowed to make to the property during the lease term.
Be sure to enter a "lease-option agreement" rather than a "lease purchase agreement". - The former grants the option to buy at any time during the rental period, while the latter requires purchase by the end of the lease period and has legal ramifications for backing out.
Do market research and obtain a home inspection. - This is how you can be sure the home purchase price is fair before ever signing a contract.
Be aware that if the seller is unscrupulous, he or she can refuse to sell at the end of the lease-option period. - This means that all the above-market rent money paid will be lost. A seller may also try to back out of the contract if the real estate market has appreciated rapidly and the property significantly increases in value. Of course, neither of these actions is legal, but if the buyer doesn't have the financial resources to hire a lawyer, there won't be much recourse against dealing with a shady seller.
Understand that if the market declines, the buyer will still have to pay the higher price stipulated in the contract to own the home. - However, if the price is too high, the lessee can just walk away and shop for a different property. However, the buyer will lose that portion of the rent that would have gone toward a down payment, so it's important to do the math necessary to determine whether walking away is the best option.
Talk to a mortgage broker and ensure that you're in a position to buy the property. - Even if the lessee decides to buy the house, it is possible that he or she will not qualify for the mortgage loan required to make the purchase. Finding this out before entering a lease purchase agreement, therefore, can save a lot of grief down the line.
Obtain a condition of title report. - This can help a buyer learn how long the seller has owned the property. The longer the seller has owned it, the more equity and stability he or she should have built up in it.
While lease purchase arrangements can have many potential pitfalls, they can be a win-win situation between a trustworthy seller and a prudent, financially responsible buyer. If you can find an arrangement that you can agree on and a house that you'd like to own one day, this could be the perfect way for you to step out of your apartment and put down some roots.
It is also strongly advisable to find yourself a buyer's agent or broker to help you with this whole lease purchase agreement. They will have experience dealing with the pro's and con's, and can point out things you may never think of on your own.
We believe the information contained in this newsletter to be accurate. It is presented with the understanding that we are not engaged in rendering legal, accounting, or other professional advice. If tax or other professional assistance is required, utilize the services of a CPA, attorney, accountant, or other consultant as may be required.