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Understanding Real Estate Lease Option

Aug 24, 2007
A lease option is similar to a purchase option in that it grants investors the right to purchase property at a predetermined price within a stipulated period of time. Lease options combine the basic lease or rental agreement with an option to purchase contract. The primary difference between these methods, however, is that lease options are typically used with property such as a single-family dwelling that might otherwise be rented to a tenant.

For example, if you sell a house using the lease option technique, your buyer/tenant is granted the right to purchase it within a specified period of time for an agreed upon price. As a purchaser of property using this technique, you may be given control of a rental house and have the right to sublease the property if so desired, provided the owner of the property has granted this right within the agreement.

Under the lease option agreement, a nonrefundable option fee, or some other form of valuable consideration, is given instead of a rental deposit, which is typically refundable. Furthermore, a portion of the monthly lease amount is typically applied toward the purchase price.

In general, the lease option technique is one of the quickest and least expensive methods available to investors for buying and selling real property. There are several advantages to using the lease option technique. One of the primary advantages is that the purchaser is not required to conform to the various underwriting guidelines that banks and other lenders require.

In addition, buyers can often option a property with very little down, which in turn enables them to increase their buying power. The seller, unlike an underwriter working for a mortgage company, is likely to require very little in the way of documentation.

The more traditional lenders like banks and mortgage companies, on the other hand, can be very particular where the money for a down payment comes from. In many cases, the money cannot even come from a family member or friend. Moreover, with this type of stipulation, borrowers must be able to prove that the money is their own and did not come from a relative.

Another advantage of using the lease option technique is that it allows investors to save money by avoiding the fees and transaction costs commonly charged for new loans. Remember also that the option fee is nonrefundable, unlike most rental deposits.

Finally, the time needed to close on a transaction when using a lease option is much less than for traditional financing arrangements since there is no loan approval process, appraisal, survey, or title search required.

One caveat to be aware of when using the lease option technique is the due-on-sale provision embodied within almost all mortgage instruments. This clause gives the lender, or mortgagee, the right to accelerate the loan balance in the event that the borrower, or mortgagor, sells or transfers his or her right in the property.

With a lease option, the seller's interest in the property is not transferred until such time as the buyer exercises his right to purchase the property. At that time, conventional financing is often used to replace any existing debt on the property.

When using the lease option technique as a seller, you should try to collect the maximum amount of option money you can. The more buyers or tenants have invested into your property, the better they will take care of it and the more likely they will be to exercise their option when the time comes.

The amount of the premium will vary depending on where your property is located. In general, an option premium for an average-priced single-family house can range anywhere from $1,000 to $5,000, and sometimes more. An average-priced house in one area, however, may be $100,000 while in other areas it may be $250,000 or more.

In short, the lease option technique is similar to a purchase option in that it grants the right to investors to purchase property at a predetermined price within a stipulated period of time. The lease option technique, however, combines the basic lease or rental agreement with an option to purchase contract. Whether you are a buyer or a seller, lease options provide greater flexibility in structuring transactions while simultaneously reducing your level of risk.
About the Author
Adrien Brody ( http://propertysmarty.com ) is a full-time real estate investor. He has been researching investment strategies and make his own living. You can learn more about lease purchase strategies at http://leasepurchaseinvestment.com .
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