What Exactly Is a Lease Option on a House?

There are several types of Lease Options for a House; but in general, when a person refers to a House on a Lease Option they are referring a person staying in the house, and renting (Optionee), as having the right to buy the house, but not the obligation to buy it. However, when a seller (Optionor) has determined that their house can or should be sold on a lease option they are obligating themselves to sell this house to the buyer.

That is the general concept of a lease option; but there are many variables that can be built into the agreement – such as only purchasing rights but no right to move into the property.

This particular article is looking at the seller’s view on a lease option – not so much the buyers view.

Is Lease optioning the Way to go for You?

Should I Lease Option My house?

To determine if you should lease option your house you need to know your end goal. By lease optioning, you are delaying the sale of your house, which of course delays income. There may be reasons for this; such as wanting income at a later time when your taxes will be lower. Another reason might be that you believe the property will appreciate and you will get a better return on your money.

If your first reason is timing – wanting a cash out in a different year, be sure and have that in your Lease Option with the buyer. I have had instances where buyers decided to just exercise their option in under a month; if that had been something I needed to be delayed for a tax reason it might have been disastrous. You should specifically indicate in your lease option if they can exercise their right to buy early.

If you think the property is going to appreciate but you don’t want to hold on to the house; be sure and analyze the potential that you are wrong. What if the property does not go up – instead, it goes down? Then What?

You specifically need to think about the cost to the buyer; will it be a set price for the future? or will you be setting it at the going rate at the time they decide to exercise their right? If you choose the appraisal in the future (at they time they actually purchase), be specific on how this sales price is determined. You can put in your contract that it’s determined at the appraised value on the date of exercise – but who actually determines the value? That can lead to conflict if you’re not specific.

Is a Lease Option Worth Less if the House Value Goes Down?

The actual value of the option does not necessarily go up or down based on the value of the house. In general, if you sell a house on a lease option but the value of the house goes down either the optionee (buyer) will not excercise their purchasing rights or if they do, their lender may not allow them to purchase at an elevated price above the going average.

What I have found with lease options is if the optionee can buy the house but it’s overpriced they will not buy it. Most lenders, however, will allow the house to be a little over the going rate since it was a lease option. I have not found much resistance to this – but areas and times do change.

Why Should I NOT Lease Option My House

I’ve aluded to them above. But I’ll go over them again.

A lease option is not always recommended in a Sellers market because a seller can usually get more NOW rather than waiting and speculating that the market will go down. Also, it comes with complexity that is not found with a simple selling of property. You have the potential for a tenant buyer to back out and lose their lease option down payment which can make them litigious.

If your goal was to do a lease option and make that tenant responsible for everything so you could be a hands off landlord – this is probably one way to do it. But I guarantee as soon as a furnace or air conditioner breaks they will be coming to you.

conflicts with contracts

When Should I Lease Option My House

You should only lease option your house when you do not need the cash-out and in general when the market is a buyers market. When it’s a sellers market and you want to sell; you will probably earn more by selling in a hot seller’s market.

If you are lease optioning your house and it’s a sellers market you may be sacrificing your upside; you are gambling that the price will go up and setting the price accordingly. In general there are two ways to set the price; at a set amount or a flexible amount based on the market.

If you have a set rate you are stuck with that rate when they decide to purchase. I have had it where the buyer buys a house slightly above market but the lenders know that a house has a little more value when it’s offered on a lease option and had no issue with the asking price.

If, however, the price had gone down substantially I would be out of any upside and if the buyer didn’t buy, I would have to move someone else in.

What Can Go Wrong With a Lease Option?

Truthfully, the number of issues are as numerous as there are people.

There are two main issues with lease options; if a buyer runs out of their time for lease optioning and they can’t or don’t want to purchase they can feel upset about having put a large chunk of money down. Secondly, there is an unjustified myth to lease options that the seller just wants the chunk of deposit/downpayment and not to actually sell the house- this can create friction.

While this might be true; the sellers with scrupples do not aim for this. One of my competitors, with questionable morals, would set people up with large down payments then if they messed up on their lease by not crossing-the-T’s he would toss them out and get new buyers. Example; he would end their lease if they were a day late on a monthly payment. That is probably not legal in most places – thank goodness.

I should mention be very clear with your lawyer and understand anything they tell you when they analyze your lease documents – you don’t want to be in litigation.

Read my book “Taking the Mystery out of Lease Options” – I cover basic lease options and sandwich lease options.

Can a Lease Option Buyer Make Improvements on My House?

The real question isn’t “Can they”, but “Should they”.

It is not recommended that a Lease Option Buyer do any significant improvements to your house while it’s under a Lease option. There are some areas in which the buyer may have more claims to a property than just the rental portion if they do extensive repairs. This should always be discussed with a lawyer.

It may be tempting to let your lease buyer fix up the house; add a new roof or fix a floor – but you are setting yourself up for legal squabbles if they cannot pull the trigger on the house. What will they do then? Remove the roofing? Tear up the floors?

Let’s say they want to replace the carpeting – you can have them sign a separate document saying that if they replace the carpeting and do not purchase the house the carpeting will be left in tack in good condition – but even that has some risk – yep – talk with your lawyer.

How do I Lease Option My House

Always talk with your Lawyer.

The way to handle a lease option is to have two documents; one for the buyer that covers the actual rental of the property and then the second is the document that covers the terms for the actual Option. Never mix the two.

What you do NOT want to happen is you giving the buyer the ability to purchase the house once they have been kicked out or voluntarily vacate. The main way to avoid this is by having two separate documents but always refer in the options document that it is null and void if there is a breach of the lease portion or they leave voluntarily. Very very important that your lawyer review this.

Picture this scenario if you mess up – you kick out a buyer and put in a new one. Your second buyer wants to now purchase your house, but your first buyer jumps in the fray because they want to purchase the property even though they haven’t been living there – you will probably be sued by one or the other – or both.

What Sales Price should I set My Lease Option House At?

You would think you should just get any price you wanted – but there are certain limitations to think about.

In general, you can set a lease option house about 10% higher than the present value assuming the purchase is 18 months out or more. Most lenders will allow a little more for a house when the you’ve added value with a lease option.

This, however, is NOT true for all lenders and your lawyer should have verbiage to the effect that it’s not possible to know the going rate and what the remedy will be if they should not be able to get the loan at the rate you have stated. Will they lose their deposit? A portion? Will you lower the cost of the house? Will you force them to try another lender?

setting the price of your lease option

Can a portion of rent go towards Lease option on a purchase?

Most Lenders will allow a portion of the rent to go towards the buyers down payment. However, it is not a guarantee and the amount may be limited. It is best to address this issue in negotiation and include a description of how a portion will be applied if the lender does not accept it as a downpayment. It can be deducted from the sales price.

Here’s a BAD example: you have a house you are renting for $2,000 per month and you give them $1,000 towards their downpayment each month so that in 12 months they will have a value of $12,000 for their downpayment. Do not do this – just because you SAY they can use this money towards their downpayment does not mean a lender will agree – very few would agree to this amount. (and besides – this is waaay too much).

Let me give you a good example: In this example your house’s true rental estimate, according to your area – is the going rate of $1800. So you increase the rent for the value of the lease option and in the contract it now says that $200 is towards the downpayment – now here is the important part – make sure you talk to your lawyer about the verbiage saying something to the effect that if the $200 is not accepted by the buyer’s lender as a downpayment that you agree to discount the sale of the house by $200 per month for the lease option (I rarely extend past 12 months). This way you are giving them something but implying that they may or may not be able to use this as a down payment.

Make this very clear in your option.

Side note: if you do increase the rent above the going rate – and they back out, make sure in your contract this is not refundable.

What is a Sandwich Lease Option?

A sandwith lease option is when an investor rents a property and does not own it but acts as a middle person in which they find a lease option buyer for the property and maintain the property through closing for the actual owner. At closing they receive the difference between their price and the lease option buyer’s price. Usually this is done as double closing.

It can get very complicated and I do not recommend it for a beginner. Additionally, in some states, counties, and/or cities it might even have some technical legalities such as violating some real estate agent rules like matching buyers and sellers when you are not an agent.

Stay clear of this unless you are willing to take the risks and have thoroughly vetted it with your lawyer.

you can read my book “Taking the Mystery Out of Lease Options”.

Important Terminology for Lease Options

Here are some common terms you need to know for lease option

Buyer– The person buying the house from you – sometimes called a tenant buyer.

Lease options – The act of renting a house and receiving (or giving) the right to buy the house at a certain price by a certain time.

Leasee– The leasee is the person who is the tenant.

Leasor –The owner – you are the leasor of the property in which you want to sell. mortg

Mortgagor – The person who is the borrower.  It seems like they should be the mortgagee, but they are not.  They are the mortgagor because they are the ones who GIVE the mortgage to the bank as collateral.

Mortgagee – This is the lender.  It seems like they should be the mortgagor but they are not.  The bank is RECEIVING the mortgage from the borrower as collateral for the loan.

Option – The act of receiving or giving the right to an individual or company to buy the house at a set price within a set period of time.  The distinction between an option and lease option is that an option does not contain rental provisions, only the right to purchase the property.

Optionor – The person GIVING the option to a buyer to buy a property. 

Optionee – The person who has the right to purchase the property with an option.

Seller – You, the person selling the house

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