Lease Options

by | Oct 17, 2022

Introduction

When you’re looking for a home, you might have a lot of questions going around your mind. What options do I have while making an agreement? Is it better to rent or buy a flat? What documents do I need to rent a flat? How much should I spend on a monthly basis? But most importantly, should I use a lease option on the property?

With so many details involved in a lease option agreement, it can be hard to know where to start. Luckily, we’ve got you covered!

We’ve put together this comprehensive guide on what a lease option agreement is and how it works. We’ll walk you through some of the key considerations when reviewing or writing a lease option contract and give you some tips on how to protect yourself from potential problems.

What Is a Lease Option

Let’s start from the basics.

A lease option agreement allows a home buyer to rent a house, while simultaneously giving the tenants an option to buy the home in the future. The landlord, who is offering the lease option, retains ownership of the property until the tenant decides to exercise the right to purchase.

Once the tenant decides to buy it, he/she is required to make an initial payment and sign a lease option contract with the seller. The tenant then has an agreed-upon period of time to come up with the rest of the money needed for the down payment and closing costs. Nonetheless, the tenant will still pay both the current rent and any further rent owed under their lease option agreement.

The lease option contract in the tenancy agreement also includes an agreed-upon price for selling the home, which is usually lower than market value. This price may fluctuate depending on how long it takes for the tenant to decide whether or not he/she wants to buy the property at all.

History of  the Lease Options

Lease options have been around for centuries. In fact, the lease option was used in the US in 1789 when George Washington leased land to farmers for the purpose of growing crops.

The first recorded lease option in California was in 1849 and involved a gold mine. The lease option was created so that a prospector could use a piece of land while he searched for gold. If he found gold, then he would be able to purchase the land from its owner at an agreed-upon price.

Lease options can be used to protect property owners who want to sell their land but don’t want to wait until they find a buyer. 

They can also help buyers who may not have enough money to buy the property outright but want to ensure they will be able to buy it in the future.

According to the landlord and tenant act 1954, the seller adopts the lease option to collect a down payment on the buying option. The practice is still common today, it is also possible for a tenant to buy property this way under certain circumstances.

Lease options have been around for decades. In the past, they were primarily used by commercial developers who wanted to sell houses or apartments before the building was complete. Click here to find out more details.

The developer would find a buyer who would lease the property for a specified period of time (usually 6-12 months) with a lease option and then purchase it at the end of that time (i.e lease option) at the set price.

happy couple signing a lease option

Why Use Lease Options

Lease options are a great way to buy real estate. Lease options allow the potential buyer to secure the option to purchase a property for a determined period of time. Usually, it goes from six months to two years.

In the meantime, you can rent the property and live there, paying rent and maintaining the property as if it was already yours. At the end of the lease-option period, if you want to move in permanently, you exercise your lease option to purchase. If not, you walk away from the deal with no further obligations.

Lease options are a good choice when:

  • You want to live in a nicer home than your current one for a short period of time but cannot afford to make such a large investment now
  • You want peace of mind knowing that if things don’t work out with your current home situation, there is an alternative available that won’t cost much to sign up for

Why Would a Seller Ever Agree to a Lease Option

A lease option is a contract between a seller and a buyer where the buyer has an option to purchase the property for a certain price at the end of the lease option term. Although it may seem like an easy way to get into a home, there are some drawbacks to lease options that can make them unattractive to some sellers. 

Nonetheless, here are five reasons why a seller might want to agree to a lease option:

  • The seller needs cash flow
  • The seller wants to keep their credit score up
  • The property is difficult to sell because it’s in bad condition or overpriced
  • The owner wants more time to find another place before moving out
  • Tenants want extra time before having to give up possession of their current home

Why Isn’t Everyone Using Lease Options

Here are some reasons why you might not want to use a lease option:

You’re looking for a long-term rental property. Lease options are great for investors who want to buy real estate and sell it after a few years, but they aren’t well suited for people who are looking to rent out their homes or apartments long-term.

That’s because if you don’t sell the property quickly enough, you could end up stuck with a tenant who won’t move out when you need them to (or who refuses to pay).

You don’t have access to private money. Lease options require cash up front, so if you don’t have money saved up or access to private capital, then they probably aren’t right for you at this time.

How to Use Lease Options

Lease options are one of the most popular ways to buy real estate. They allow you to purchase a home for a pre-set amount, and then buy it later on.

A lease option is a contract between two parties: the buyer and the seller. The buyer pays an upfront sum and in exchange gets the right to purchase the property. The option can be exercised until an agreed-upon date in the future. The buyer also pays the rent while they own the lease option.

The seller gets an upfront payment from the buyer, which helps them pay their mortgage while waiting for their home to be sold. When they sell it, they get an additional lump sum payment from the tenant/buyer.

rental contract with lease option

 There are three ways to use the lease option:

1. Purchasing an Option

The first way is for the buyer to purchase a lease option for a set amount of time, usually one year. The lease option price is usually equal to about 5% of the purchase price of the home. 

If the buyer exercises the lease option and buys the property, he or she will also pay any necessary closing costs and prepaid items such as insurance or taxes. If they don’t exercise their right to buy during that year, they lose their deposit, which means they have wasted out their initial investment in purchasing a lease option.

2. Selling a Lease Option

If you own real estate that you want to sell but don’t want to wait until it sells in order to get top money, selling a lease option may be in your best interest.

You receive immediate cash while still being able to participate in any appreciation in value that occurs before your property sells on its own or, at least, gets paid back for what you invested into it.

3. Exercising the Option

Lease options are typically used by investors who want to buy rental properties with no money down. They are also used by people who want to purchase homes but can’t afford them yet, perhaps because they have too much debt from previous home purchases or because they’re just starting out in their careers and haven’t built up enough savings yet.

Benefits for Landlords

If the tenant decides to buy the property during that time, they can pay an agreed-upon price and take ownership of the home. This can be advantageous for both parties because it allows them to get to know each other before making a big decision about purchasing a home.

Benefits for landlords in lease option agreements:

  • The lease option allows you to sell your property at any time, without having to worry about finding another buyer. The lease option contract is only between you and your tenant, so if they decide not to buy, after all, you can sell it again with no problems
  • You don’t have any financial obligations until after your tenant exercises their option or decides to buy your home. You don’t have to pay anything until then; all expenses are covered by rent payments during this period of time
  • You don’t have any financial obligations until after your tenant exercises their lease option or decides not to exercise it

Are There Any Downsides to Lease Options

Lease options are a great way to get into your dream home without having to pay for it upfront, but are there any downsides to lease options?

Here are a few things to consider before signing a lease option:

Lease Option Fees

Some people say that the fees associated with lease options can be exorbitant. While this can be true, it’s not always the case. The best way to avoid getting ripped off is by doing your homework on the broker you’re considering using. If they’re reputable, they’ll likely have several satisfied customers who can attest to their services.

The Required Down Payment with Lease Option

While most people think of a down payment as a large sum of money, in most cases it’s actually quite small, usually around 1% of the home’s cost or less. However, if you plan on buying with a loan (which has lower down payment requirements), then you’ll have to put 20% down instead of 10%.

You Can’t Sell Your Lease Option

If you decide that you want to move out of town or upsize, and you don’t have a break clause tenancy then you may not be able to sell your lease option to another buyer because most states require that buyers who purchase options pay the same price as buyers who buy houses outright. 

You Can Lose Money on The Lease Option

If you don’t buy the house at the end of your lease, you lose all of the money you’ve put down on the lease option. However, if you do buy the house and it appreciates in value during your contract period, you can save yourself from having to pay taxes on that appreciation. 

You May Have Difficulty Finding a Buyer

If there are no buyers for a particular house when your lease expires, there’s no one for whom you can sell your lease option and recoup some of your initial investment unless it’s someone who plans to live in the property themselves.

keys insert in an open door

Lease Options Warnings

If you’re considering a lease option, be sure you understand the terms and conditions of the leased and released agreement. 

Here are some things to watch out for:

The option fee is often non-refundable. If you decide not to purchase the home, the fee will be forfeited.

You May Have to Pay Rent on the Option Period

If you don’t buy at the end of the lease-option period, you may be responsible for monthly rent payments until the end of your lease-option term. The landlord can also charge you late fees if you don’t pay on time.

The Tenant Doesn’t Have to Move Out at the End of the Lease Term

If you intend to live in the home after your lease option expires, make sure there’s no language in your lease that would allow your tenant to stay in place. 

After their lease option expires and continue paying rent until they find another place or until their contract with their new landlord starts up again.

A Lease for More Than Two Years

If you want to rent or buy an apartment or house for more than two years, then you will need permission from your landlord. 

Most leases are only good for one year, but if you want something longer-term, ask your landlord about extending it before signing anything on paper or agreeing orally.

Relocation and Redevelopment Causes

Some lease options contain clauses that allow your landlord to relocate you without penalty if they need another tenant in the building or if they plan on redeveloping the property where your apartment or house is located. 

Demolition Clauses

Many properties are sold as “land” with no mention of what will happen if the land is needed for development. Some developers include demolition clauses in their lease options, which allow them to take back the land at any time.

This means that if your property is near a site that’s been earmarked for development, it might not be worth buying onto a lease option because you could lose all your money if you don’t sell it quickly enough.

Vague and Unrestricted Fees and Outgoings

Some developers charge fees that aren’t clearly defined or have no limit on how much they can increase over time. They may also charge an ongoing percentage of each sale without stating how this will be calculated or what profit they make from it (if any).

The same goes for any other outgoings such as insurance or maintenance costs, these should be clearly defined in the lease option before signing anything!

property sold using lease option

How to Find Lease Option Opportunities

The first step in using a lease option is to find a great property. You can do this by searching for “for sale by owner” listings on the internet, or by searching for properties that are under contract with their current owners.

Once you find a property that meets your criteria and budget, you will want to call the listing agent and set up an appointment to see the home.

During this initial visit, it’s important to act like any other buyer would. You may want to bring someone with you who has experience with real estate (or at least has been through the process before). 

It’s also important to take notes while you’re viewing the home so that you can remember everything about it later. 

Once you’ve done this, get back in touch with the seller and tell them what you liked about what they had to offer. Ask them if there are any other properties that they might recommend that would be similar in style and location. 

How Do You Put Together a Lease Option Agreement

When it comes down to real estate, there’s no single right answer for every situation. You can put together a house or commercial lease option agreement yourself but you should consult an attorney before doing so.

The following are some of the key considerations that should be included in your lease option agreement: 

Utilities

Who will pay for utilities? If the tenant pays for utilities, specify which ones and how much they are expected to pay. For example, if the tenant will pay for electricity but not water or garbage collection, indicate this in your agreement.

Rent

How much will the tenant pay each month? If rent is paid on a weekly or biweekly basis, include this in your agreement as well. Also, include whether or not there will be any late fees if they don’t pay on time.

Maintenance

Who is responsible for what maintenance? The landlord should be responsible for any repairs needed on the property while it’s being used by the tenant as a residence (for example, broken windows). The tenant should be responsible for any repairs needed on the property after its use as a residence ceases (for example, fixing holes in walls).

Lease Option Period

How long do you want the lease option period to last? And what happens when a lease expires/? A landlord who is interested in leasing their property out usually chooses one year, but two years is also common. Click here to find more

Potential buyer signing a lease option

Lease Options – An Affordable Option for First-time Buyers

Some first-time homebuyers don’t have the down payment or credit history to qualify for a mortgage. A lease option can be an affordable way to get home.

Here’s how it works: You pay the owner’s rent, but you also make monthly payments toward a purchase option. When you exercise your lease option and buy the property, you make one last payment, usually, 5% of the purchase price, to exercise your right to buy.

A Lease option is similar to renting-to-own arrangements, except that you’re not required to make rental payments after you exercise your purchase lease option.

If you don’t want to buy the property at some point in the future, then this arrangement isn’t for you. But if you want to own a house and don’t have enough money for a down payment yet, the lease option called an AST agreement could work well for you.

Here are three reasons why choosing a lease option agreement is so important:

  • It helps prevent the owner from selling the property during the option period;
  • Helps fix a price.
  • You don’t need to take out a mortgage and you generate income every month, just like if you owned it. 

Rent-2-Buy Agreement

A rent-to-buy agreement is an arrangement in which a landlord rents property to a tenant who has the lease option to purchase the property at any time during the lease period.

The tenant makes regular monthly payments on the rental portion of the contract and deposits them in an escrow account. At any time during the lease, the tenant may exercise the option to purchase by paying the seller a predetermined amount, usually 20% of the value of the home, and taking over ownership of the property.

Lease option agreements are common in areas where there is high demand for housing but limited supply. They also may be used to help families move into better neighbourhoods, or schools or for older people who want to stay in their homes but can’t afford to buy new ones.

However, most homeowners are unaware of technicalities and often question what documents they need to buy a house. 

Rent-to-own agreements are similar to lease-purchase agreements except that they require tenants to make larger down payments and have shorter periods before they can take ownership of their homes before tenancy check-in.

Tenants looking at the floor plan with property manager

Conclusion

A lease option is a contract between a property owner and an investor who wants to purchase the property. The investor pays rent on the property while they are waiting for the contract to expire, which gives them the option to purchase the property.

If they do not exercise their option to buy, then they forfeit all of their rights to purchase it.

Whether or not it’s right for you depends on your personal goals and circumstances, so use this guide about lease options as an educational tool in deciding whether or not using a lease option is right for your situation.