Lease-options, also known as “rent-to-own”, “lease-to-own”, “rent-to-purchase”, etc, are a type of real estate transaction whereby the tenant/buyer initially leases a home or property for a specified period of time before purchasing it. It is really a conventional lease and a purchase, tied together with an option agreement or contract. For the privilege of the option, the tenant/buyer will pay an option deposit, which can be $10,000, $20,000, or much more (this is addition to a security deposit and monthly rent). The option deposit is typically applied to the buyer’s down payment.
The process appears very attractive to many hopeful buyers, who see a lease-option as a short cut or back door to home ownership. This is especially true for younger buyers and those with little cash, low income, bankruptcies, or poor credit. Unfortunately, a lease-option is completely unsuitable for these types of buyers and entering into one will only deepen their financial woes.
First off, ask yourself why a home seller would even offer a lease-option? The answer is because it is more of a “win-win” for them than for the buyer. Lease-options are typically offered as a sales gimmick to help move a home that cannot sell. This may be because the seller would be “short” if he sold at market value, or perhaps the seller simply wants to sell at a certain price. For the seller, there is little down-side. The seller either parts with the home for his price, which is often well over market value, or in the worst case, leases the home out for a year or more and then collects a large option deposit, when the tenant/buyer fails to execute on the purchase.
So why do lease-options seem so attractive to buyers? Mainly because many buyers are as un-knowledgeable about the lease-option process as they are ill-prepared for home ownership. To illustrate, here are some lease-option myths:
1) I will “build equity” through a lease-option, because the rental payments apply to the purchase – Wrong! I have yet to see a single instance of a homeowner offering this. At most, I have seen a handful who will offer to apply a small percentage of the rent towards the purchase, but only if the rent is increased by the same amount!
2) The seller will finance the purchase – Wrong! When your lease period is up, the seller will expect you to “execute” the purchase or give up your deposit. This means you will have to go out and get a loan, plus put up the remainder of your down payment (over the amount of your option deposit).
3) It’s a great real estate technique for people with poor credit – Wrong! If you have poor credit, it is unlikely that you will improve your financial situation substantially in a year or two. With poor credit, you will not be able to qualify for a loan; therefore your option deposit will be at risk!
4) It’s a great way to “test drive” a home before buying it – Wrong! The number of homes offering lease-options is miniscule — Real home choice is virtually non-existent. Also, if you decide you don’t like the home you will pay a heavy price for your test drive (your entire option-deposit).
5) I will have several years to improve my credit and save for the down payment – Wrong! Most lease-options are for 12 to 18 months only! You are unlikely to meet your financial goals in such a short time period. Plus, no seller will risk a longer term, as the market price could fluctuate wildly.
6) I may get a great deal if the home price rises during the option period – Wrong! More than likely you will wind up in a law suit when the seller reneges on selling at the original offer price. Many of the lease-options that wind up in Court, do so because of home price fluctuation or because the seller refused to return the option deposit when the buyer fails to execute.
7) If the value of the home drops substantially during the lease period, the seller will agree to return my option deposit (when I refuse to buy the home) – Wrong! He will gladly pocket your deposit, in full!
Considering all of the above, I’m wondering why I see so many Internet articles or Blogs stating that a lease-option is a “great way to get into home ownership”, “a great way to build equity”, or that it is “ideal for people with poor credit or little down payment”. I have to assume that the authors, be they fellow Realtors or others, are doing so for their own benefit. It seems to me that they should be letting you know that close to 95% of lease-options fail to consummate in a successful sale (see link by John T. Reed, below). This means that the vast majority of people entering into a lease-option wind up poorer and homeless at the end!
So what should you do instead?
1) Consult with a lender up-front rather than at the end of an option period. This is the first step you should take and you will save a lot of heartache if you find out that it will take more time than you thought to get qualified. I have several lender referrals on my web page here: http://www.ronforhomes.com/about.htm
2) Rent, and rent cheaply. When you are ready to buy, you will have saved money and you will have the entire market of homes for sale to choose from, rather than a dozen or so in your city that are offering a lease-option.
3) Save money and work on improving your credit. Set your own timetable for doing this, rather than being forced by an option time period.
4) Check market values by asking your Realtor to run “comps”. You may find that the home offering that attractive lease-option is very over-priced.
5) Be realistic. If you are not ready to buy because of your financial situation, don’t try to achieve home ownership through short cuts, gimmicks, AITDs, a loan take-over, creative financing, and other risky techniques. You will only find yourself far deeper in the ditch!
To recap: If you are a buyer, understand that lease-options are not what they appear to be. Like my illustration, think of them as a “wolf in sheep’s clothing”. They are largely of benefit to a seller with little or no benefit to you, the buyer. If you are a buyer who is financially challenged by credit issues, lack of a down payment, a short sale, foreclosure, a bankruptcy, etc, do not look for a “magic bullet” or quick solution to home ownership. The path to true home ownership will be challenging and time consuming, but in the end, it will be obtainable!
PS – Here is a link on lease-options from a real estate investment advisor that I greatly respect. John T. Reed offers a unique perspective on lease-options that you will rarely hear from many Realtors or others who might profit from getting you into an option contract:
Ron Denhaan is a Realtor in Orange County, CA. He can be contacted at (949) 290-3263 and at firstname.lastname@example.org Please visit his web site at: www.ronforhomes.com.