How to Buy the Home You Want with Easy Terms Copyright Duncan C. Wierman
How to Avoid Lease/Option Rip-Offs
And Buy the Home You Want with Easy Terms
Thousands of families all over the United States buy homes every year through Leases with Option to Buy (also called “Lease/Options”). For most of these Americans, a Lease/Option is a great way to live in the home of their dreams while they improve their credit, save money for a down payment, or build extra value into the home by making upgrades, repairs, or improvements.
Unfortunately, recent newspaper and TV reports have focused on a few home buyers who have gotten into lease/options that were NOT good deals. In many cases, the “terms” of the lease/option contract were so strict that it’s almost impossible to follow them. In others, the home had so many hidden problems that the buyer couldn’t afford to make the repairs.
Still, the RIGHT Lease/Option can be a great way to buy a home. In fact, Lease/Options have been used for decades by folks with bad credit, short time on the job, or not enough down payment to get the home they want NOW.
And if you know what to look for and what to avoid in a Lease/Option deal, you too can make a smart decision about buying a home this way.
What Is a Lease/Option?
A Lease/Option is a legal contract that gives you the right to live in your home today, along with the right to buy it in the future at a price you agree on now.
A true Lease/Option is actually made up of two different documents. The first is a lease that says what the monthly rent will be, when it’s due, how much the late fee will be if the rent isn’t paid on time, whether you can keep pets, and all of the other things that any lease says.
The second document is the Option to Buy, which says that you have the RIGHT–not the OBLIGATION–to buy the home. The Option to Buy will say the price at which you agree to buy the home, and how long you have to buy it. It should also have information about who pays the expenses at the time that you actually buy the property–for example, it will probably say that YOU pay for the mortgage application fee, the appraisal, and the loan costs. It will probably say that the SELLER pays for the real estate taxes up to the day that you buy the property and pays to have the deed or deed of trust prepared and for any transfer taxes that your county requires.
A good Option to Buy contract should say that you have the ABSOLUTE RIGHT to buy the property as long as you keep up your end of the contract. If you pay your rent on time, get a mortgage on or before the due date in the option, maintain the property, and don’t break your lease or violate any of the clauses, the seller should NOT be able to refuse to sell the property to you for any reason!
What Are the Advantages to Me of Buying on Lease/Option?
There are a lot of great reasons to buy a home of your own. Not only does owning your own home mean that you have total privacy (no landlord making inspections) and total control (if you’ve ever had to move because your landlord sold the house you’re renting, you know what I mean), but owning your own home also means that you’re investing in your financial future.
Think about it this way: right now, you’re probably renting. Every month, you work hard to earn the money for your rent. Every month, you give that money to your landlord, who uses it to make the mortgage payment on the house you’re living in. After 30 years, you’ve bought your landlord a free-and-clear property!
On the other hand, if you BOUGHT the same home and made payments on it for 30 years, YOU would be the one who owned the free and clear property.
And how much would your home be worth in 30 years? Well, on the average, home prices in the United States double about every 10 years. So, instead of a worthless pile of rent receipts, you’d have a paid-off home worth as much as FOUR TIMES what you paid for it! Think of what you could do with all that value–you could sell the home to pay for your retirement or your children’s college education; you could keep living in the house through your old age, then leave it to your kids or grandkids as an inheritance; or you could sell it or refinance it to pay for a dream trip around the world or a retirement home somewhere nice and warm!
So, why don’t you put down this report and go out and buy a home right now? It’s probably because you can’t–at least not by the “traditional” method of going to the bank and qualifying for a mortgage. About 4 out of 10 Americans don’t have the credit or down payment to get a regular mortgage. And that’s where a Lease/Option comes in.
When you Lease a home with the Option to Buy, you get the advantage of living in your home now and setting the price now, but have several months or years to straighten out your credit or save a down payment to go to the bank. Also, when you make improvements to the property (like adding a deck, upgrading the bathroom, or landscaping the outside), the VALUE of the property goes up, but THE AMOUNT YOU OWE DOESN’T GO UP. This is called “sweat equity,” and it’s a way to develop a “down payment” in a home through labor.
“Sweat Equity” works like this:
Let’s say you have an option to buy your home for $90,000.
While you live there, you landscape the yard, build a deck, and put a new vanity, floor, and medicine cabinet in the bathroom. The flowers you plant, wood and screws you use for the deck, and materials for the bathroom cost you $2,500. Thanks to the upgrades you’ve made to the home, it appraises for $97,000 when you’re ready to buy.
But the price you owe to buy the property is still just $90,000.
That means that the additional $7,000 in value is all yours when you buy. Many lenders will consider this $7,000 as a “down payment”–just as if you’d actually brought $7,000 cash to the closing.
And since your total investment in the property is $92,500 ($90,000 to purchase it + $2,500 in materials), you have built an extra $4,500 in value into your own home!
Another little-known advantage of the Lease/Option is that it gives you the RIGHT to buy the home–but you don’t HAVE to buy it if you don’t want to.
If you’re new to an area and want to “test drive” a particular neighborhood or home before you buy it, a Lease/Option is the only way to do it.
If you aren’t sure you’re ready to purchase a home and want to try out the responsibilities of home ownership for a year or two, Lease/Option is the way to go.
If you live in an area where home prices are declining or where you think they might go down (usually in the large cities on the east and west coasts), you can Lease/Option a home for awhile to see what happens. If prices go down, you just don’t buy.
And if you Lease/Option a home with every intention of buying it, but something happens in your own life (like a job transfer or new addition to the family) that makes the home you’ve chosen the WRONG home, you are under no obligation to purchase it at the end of the lease term.
When you chose not to buy your Lease/Option home, all you lose is your OPTION FEE (which is usually a LOT less than the down payment you would have made if you’d purchased the home), the rent you’ve paid (and you would have paid rent SOMEWHERE during the time you lived in your home, right?) and the cost and value of any upgrades or repairs you’ve made.
What Are the DISadvantages to Me of Buying on Lease/Option?
Any housing choice you make has advantages and disadvantages. We’ve already talked about some of the down sides of renting–you have little privacy, no control over what happens to the home, and you pay for someone else–your landlord–to buy a property.
There are also disadvantages to BUYING a home. You are totally responsible for all repairs, maintenance, and expenses. If you have to sell within year or 2 of buying the home, you’ll often lose money at the sale, thanks to the Realtor’s commission, transfer taxes, and other expenses of the sale.
Likewise, Lease/Options have some disadvantages. If you can’t keep your end of the agreement–like paying the rent on time, maintaining the house, and so on–you’ll probably LOSE your right to buy it, along with your option fee and your investment in repairs and upgrades.
In a Lease/Option, you’ll be expected to do all the normal maintenance–mowing the lawn, changing the furnace filter, painting, replacing the washer in the drippy faucet–which you may be used to your landlord taking care of.
And you’ll also be personally responsible for fixing whatever problems are keeping you from qualifying for a mortgage now. If your credit is bad, YOU will have to pay off judgments, collection items, and lines of credit. YOU will have to get negative items removed from your credit report if they don’t belong to you. And YOU will have to be careful to make all of the payments you owe to creditors ON TIME, every month. No one can do these things for you, and if you don’t do them, you probably won’t be able to buy your home when the time comes.
But if you’re serious about buying a home and are willing to take on the responsibilities that buying a home requires, a Lease/Option can be exactly the right deal for you.
What’s in a Lease/Option Contract?
There are as many different Lease/Option Contracts as there are buyers and sellers of Lease/Options. Each one is laid out a little differently, and some are written in easier-to-understand language than others. REMEMBER: Every Lease/Option contract is a LEGAL DOCUMENT, just like a rental agreement or a contract to purchase real estate. If you don’t understand what you’re agreeing to, you should take the contract to an attorney, to pre-paid legal, or to someone you trust who understands legal language.
Still, most Lease/Option Contracts have certain things in common. In the lease, you can expect to see:
- A Lease “term,” that says how long you will live in the house under the Lease. The Lease term is usually the same as the option term–for example, if you have 2 years to buy the property, the Lease will also be 2 years. If the Lease term is SHORTER than the option term–for instance, if the Lease is for 1 year but the option is for 2 years, ask the seller to put IN WRITING how the rules will change in the second year. For instance, will your rent payment go up? If so, by how much?
$The amount of the monthly rent during the Lease term. This should be stated clearly, and there should NOT be language that says that the seller can raise the rent during that time if you’ve made all of your payments on time. Some Leases also state the rent as a yearly amount. For example, it might say something like, “Tenant shall pay $500 per month ($6,000 per year) as rent.”
$When the rent is due and when it’s late. Traditionally, rent is due on the 1st and late on the 5th of the month, but some sellers look for rent on the 25th of the previous month, with rent paid after the 1st being considered late.
$What happens if the rent is late? There is normally a late fee due when rent is paid after the due date. Some late fees are a percentage of the rent due (if your rent is $500 and the late fee is 10%, late rent will cost you an extra $50). Sometimes the late fee is a fixed amount, like $25 or $50. Sometimes it’s a daily charge, like $10 per day for every day that the rent is late after the late date.
$Where and how the rent is to be paid. Most sellers want you to send your rent in the mail. The Lease should say where the rent is to be mailed, and it should also say whether it’s late when it ARRIVES after the due date (which could be the post office’s fault) or when it’s POSTMARKED after the due date (which means you mailed it late). Most sellers will accept personal checks for rent–at least until you bounce a check to them–but some will only accept cash (which you should NEVER send through the mail) or money orders (you should ALWAYS keep your receipts for money orders, in case they get lost in the mail).
$How many people can live in the home and what happens if more people move in? Most Leases say that only you, your children, and other adults who actually applied to live in the home can live there. If other people–your friends, your parents or other family members, or even a new spouse or significant other–move in, you might be breaking your Lease. If you know that an adult other than yourself will be moving into the property, you should make sure that they are on the application and on the Lease. NOTE: No landlord can evict you for having more children–whether by birth, adoption, or if you become the legal guardian of someone else’s children–unless the total number of people living in the house is MORE than 2 per bedroom.
$Who pays utilities and how. In most Lease/Options, just like in most Leases on single family homes, you are expected to pay for gas, electric, water, sewer, and garbage removal (if your city charges extra for garbage removal). In most places, you can have the gas and electric put directly into your name–and if you don’t pay, you don’t get heat or electricity. In most places, you can have your name ADDED to the water bill, but the seller is still responsible for the bill if you don’t pay. So, many sellers and landlords are now asking you to pay your water and sewer bill monthly as part of your Lease.
$Restrictions on how you can use the home. Each Lease you see will have different rules about how you can use the home. All Leases say that you won’t use it for any illegal activity, and most say that you can’t make major changes to the property without the owner’s written permission. Some also say that you can’t have pets, or that you can’t have waterbeds, or that you can’t run a business–like a daycare center, group home, or car repair service–from the home. This is why you need to read your Lease carefully. If you agree that you won’t keep dogs in the house and then get a puppy for your kids for Christmas, you have broken the Lease and you can be evicted. And when you’re evicted, you lose the right to buy the house, as well as your option fee and any value you’ve added to the property through repairs.
In the Option Contract, you can expect to see:
$A statement that the contract gives you the absolute right to buy the home under the terms and conditions outlined in the contract. This is a very important statement; without it, the contract is not really an Option to Buy. This statement may go on to say that you must fulfill your responsibilities in order to keep the Option to Buy; for instance, that you will not break the Lease by paying rent late or by violating one of the other conditions of the Lease.
$An Option “Term,” which says how long you have to buy the house. The Option term is usually somewhere between 1 and 2 years, although longer and shorter Option Terms are also possible. Again, you should check to see that the Lease Term and the Option Term are the same.
$An Option “Fee,” which is money that you pay up front to “buy” the right to purchase the property. The Option Fee is NOT a security deposit, and it will NOT be refunded to you if you move. The amount of the Option Fee depends on the price of the house (a higher priced house will have a higher option fee), the condition of the house (a house where you’ll have to do a lot of work will have a lower option fee than one that’s in great shape), your credit and payment history (the better credit you have, the lower the option fee), and the seller, but it is usually between 1% and 5% of the Option Price.