A lease purchase option agreement can be a good choice for buyers with less than perfect credit. Many real estate investors have begun offering lease options with rental properties. Doing so allows them to generate positive cash flow and retain long-term tenants.
The type of lease purchase option agreement used depends on the state where property is located. Three types of lease-to-own contracts are used and include: lease options, lease purchase agreements, and options to purchase.
While rent-to-own contracts can be arranged to suit the needs of both buyer and seller, they must abide by state laws. Most require buyers to remit a down payment to secure the property. A portion of rental income is contributed toward the purchase price. Sellers can determine the purchase price when contracts are executed or require buyers to pay fair market value when the contract expires.
It is best to retain the services of a real estate attorney to ensure lease purchase option agreements are legally binding and adhere to state real estate laws. Contracts should include all pertinent details of the sale, along with a default clause.
A lease option is the most commonly used rent-to-own contract. Buyers remit ‘option’ money to secure the property. The downside of lease options is option money is non-refundable and does not apply toward the purchase.
Once lease option contracts are in place sellers cannot list the property for sale. Lease options cannot be sold or assigned to another party without approval from the buyer. If buyers are unable to qualify for a home mortgage loan when the contract expires they forfeit all funds contributed toward the purchase.
Lease purchase agreements are the most complex lease-to-own contracts. Buyers cannot back-out of the contract if they later decide they do not want to purchase the home. If buyers default on lease purchase agreements they could face legal consequences. For this reason, buyers must carefully weigh the risks before entering into a purchase agreement.
Buyers should obtain real estate inspections and property appraisals, along with comparable sales reports to determine fair market value. Sellers have the option to determine the purchase price when contracts are drafted or require buyers to pay fair market value when the contract expires.
Buyers are required to provide a down payment to secure the property. Sellers can allow buyers to pay the down payment over an extended period of time. For example, if the seller requires a $15,000 down payment, he can allow the buyer to provide $5,000 upfront and extend the remaining $10,000 over the term of the purchase agreement.
When buyers extend down payment funds they submit additional payments with monthly rent. Sellers allocate a percentage of rent money toward the purchase price. The average contribution falls between 10- and 40-percent of rent.
Bad credit buyers must commit to improving credit scores in order to qualify for bank financing at the end of the contract. If buyers are unable to qualify for a mortgage loan they may lose all funds vested into the property.
Lease purchase option agreements should be drafted by a real estate lawyer. Contracts should include a default clause and address possession and occupancy rights.
Options to purchase are similar to lease purchase agreements, but with one exception. While sellers are not allowed to sell the property during the contract term, they can sell the contract to another buyer. When options to purchase contracts are sold, contract terms remain intact. The only change is buyers submit payments to the individual who purchased the contract.
Both parties should conduct due diligence before entering into lease purchase option agreements. Buyers should conduct property records search to ensure the home is not in foreclosure. Sellers should conduct credit and background checks to ensure buyers are financially capable of adhering to contract terms.