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Pros And Cons Of Lease Options

Winning the bidding wars

ask phyllis real estate question, real estate q and A

Dear Phyllis,

Because we are cleaning up our credit and can’t get a loan we would like to try to find a rent to own opportunity. Can you explain how these work and where we can find these listings?

JLM

Dear JLM,

There is no specific source for rent to own listings, which are more often referred to as lease options. The best way to find these opportunities is to work with a real estate agent who is very active within the community in which you wish to live. Unfortunately, your major hurdle is likely your credit. If a bank doesn’t believe you are credit worthy, it might prove difficult to convince a homeowner to rent to you.

Lease options are not uncommon for a variety of reasons. But I will first address how one might be structured. Typically the tenant will give the owner a non-refundable deposit which will be applied to the selling price when and if the option to buy is exercised. At this time the purchase price is negotiated as well as the time period in which you have to exercise the option to purchase; typically within one to two years. Please be sure to talk with a reputable lender to be certain that you will be able to qualify for a mortgage within said time period.

Assume this scenario: You and the owner (seller/landlord) agree that the home’s purchase price will be $1,000,000. You have two years to exercise the purchase option and will pay $4,000 monthly rent. If the option to purchase is exercised, your 3% ($30,000) non-refundable deposit and $500 of each month’s rent is credited towards your $1,000,000 purchase price.

There are very few reasons a home seller would consider a lease option in today’s heated real estate environment. Tax considerations could be a reason. But why would a homeowner want to sell at today’s value if they believe their home’s value will continue to increase? Or on the flip side, If values drop you may not want to purchase the home at the agreed upon price. Even if you decide to overpay for the home, you might have difficulty obtaining a mortgage. Lenders base their loan to value on the purchase price or appraised value, whichever is less.

Why not meet with a reputable lender and begin to work on repairing your credit? A shorter term lease option – might be easier to find. For example if a vacant home has been on the market for several months without selling, the owner may be open to a short term lease option while you get your credit in order. Best of luck to you.

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