A lease option is an agreement that gives a renter a choice to purchase the rented property during or at the end of the rental period. It also precludes the owner from offering the property for sale to anyone else. When the term expires, the renter must either exercise the option or forfeit it.
Key Takeaways
- A lease option grants renters the potential to purchase the rental property at or before the end of the lease period.
- The property owner cannot sell the property to other buyers during the lease term.
- Renters generally pay a premium above the standard monthly rent, which contributes to the eventual downpayment if the option to purchase is exercised.
- Lease terms can vary but often last between one to three years.
- The contract may stipulate maintenance responsibilities and repair costs typically borne by the landlord.
How a Lease Option Works
A lease option offers more flexibility than a traditional lease-purchase arrangement, which mandates the renter to buy the property when the lease term concludes. The home’s purchase price is determined initially by mutual agreement. Charging an upfront fee for the option, usually 1% of the home’s sale price, is common. This fee contributes to the downpayment if the renter ultimately decides to buy. Lease options are beneficial for those improving their credit or accumulating savings for a downpayment.
Requirements for a Lease Option
For property owners, there’s an opportunity cost since they forgo selling the property outright at a potentially higher price. Tenants compensate by paying more than standard monthly rent to secure the leasing option.
Rental Payments
A premium is charged over and above standard rent rates for the option to buy at the predetermined purchase price, nominally a 10% surcharge. This premium, referred to as rent credit, is part of the downpayment if the lease option is exercised.
Alternatively, property owners may request a one-time non-refundable option fee, ranging from a token amount to roughly 5% of the property’s anticipated sale price.
Bank Financing with a Lease Option
Banks typically allow the premium payments over and above standard rent to contribute to the downpayment. Clients should consult multiple banks to understand financing policies related to mortgages under a lease option.
The Term of a Lease Option
The term generally ranges between one and three years, with the initial lease agreement often outlining the property purchase price or the method for determining it at the term’s end.
Lease Option Terms
Key lease option characteristics include:
- Lease Term: Period during which the tenant occupies the property.
- Purchase Option Price: Agreed-upon or calculable value indicating the price at which the tenant may buy the property.
- Option Fee: An upfront, non-refundable payment for the right to purchase during the lease term.
- Rent Credits: Potential offsets against fees or purchase prices through additional premiums paid during the lease.
- Exercise Period: Defined timeframe for notifying the landlord of the intention to buy.
- Default and Termination Clauses: Terms governing actions for unmet obligations and potential options to extend lease terms, sometimes costing a fee.
- Appraisal and Inspection Requirements: Ensuring valuation consistency and condition verification before option execution.
Industries Utilizing Lease Options
While frequently discussed within real estate, lease options apply across several fields:
- Real Estate: Assists prospective homebuyers in renting with an option to purchase.
- Automobiles: Lease agreements offering car ownership at term’s end.
- Equipment: Firms in manufacturing, construction, and healthcare use lease options to trial and potentially buy high-cost equipment.
- Technology: Software licenses and hardware leases frequently encompassed under technology lease options.
- Agriculture: Allows farmers with insufficient funds to lease with the potential for future purchase.
- Aviation: Utilized by airlines for leasing aircraft with eventual purchase opportunities.
Reasons to Enter a Lease Option
Why Renters Choose Lease Options
Renters may utilize lease options due to insufficient funds or credit or to lock in current prices in the face of potential home value increases. This strategy also allows for acclimatization to a new neighborhood, school district, or town and enables qualifying for specialized loans post-repairs.
Why Owners Offer Lease Options
Owners might opt for lease agreements due to difficulty in selling immediately or benefits like premiums above market rentals. It can also mitigate immediate tax liabilities and secure a potential buyer when market re-entry is desired.
Lease Option vs. Right of First Offer
A right of first offer (ROFO) grants one party the first opportunity to purchase should the owner decide to sell, contrasted with the guaranteed option to purchase within a lease option scenario.
Lease Option vs. Right of First Refusal
In a right of first refusal (ROFR), tenants can match an outside buyer’s terms if the owner decides to sell. Lease options provide a predetermined purchase chance upfront, independent of outside buyer offers.
Special Considerations
- Renter’s Insurance: Covers tenant belongings and is often mandated alongside owner’s homeowner insurance.
- Appraisal Contingency: Validates the property value pre-purchase, warding against overpayment.
- Final Costs Calculation: Strategic financial planning ensures owner compensation for market value gains ceded during lease option periods.
- Legal Review: Expertise safeguards against unforeseen agreement complications.
Lease-to-Own vs. Lease Purchase
A lease option grants the choice to buy, whereas a lease-purchase compels the sale at rental conclusion.
Example of a Lease-to-Own Option
Imagine a house worth $500,000 with long-term renters saving to buy a home. Instead of market challenges, the owner offers a leasing option. The tenant pays 3%–5% ($15,000–$25,000) upfront and premiums contributing to the downpayment. Should the tenant buy at terms end, they benefit from price locking, though any premium is lost if they opt out. The landlord gains initial financial benefits but forfeits sale immediacy.
How Lease Options Apply to Cars and Other Assets
In car leasing, renters pay an upfront sum followed by weekly payments, owning the car post-lease. Though more accessible than subprime loans, they’re pricier than direct credit purchases.
Finding Lease-to-Own Homes
Search through agents with lease-to-own programs, directly approach sellers, or explore pre-foreclosure listings for potential deals.
Writing a Lease-to-Own Contract
Online templates are available, but professional legal evaluation ensures robust, unambiguous contracts given the financial commitments involved.
Building Credit with a Lease-to-Own Agreement
While typically unreported to credit bureaus, requesting landlords to report rent payments can improve credits scores, using cautiously considering potential pitfalls.
The Bottom Line
Lease options help homeowners secure potential buyers and provide renters the flexibility to prepare for home ownership through savings and credit improvement, with agreed-upon future buy potential.
Related Terms: lease purchase, right of first offer, right of first refusal, rent-to-own
References
- Homelight.com. “The Six Best Methods to Finding a Rent-to-Own Home”.
- Experian. “What Are the Pros and Cons of Rent-to-Own?”
