As you probably already know, lease option purchases are a great low cost or no cost financing vehicle to control and sell a property for a nice profit. Because of the low cost and no risk, this is where many beginners start when they are ready for a career in real estate.
There are other interchangeable terms used to refer to this type of deal. A few are "option agreement", "lease purchase agreement", "lease with purchase option", "sandwich lease option", or simply "rent to own". You need to know that not only are there subtle variations to each term but almost every contract is written a little differently.
Here, I share some more advanced issues and solutions that all lease option holders need to consider before entering into an agreement with the end buyer. However, just as each deal is unique, regulations different from state to state. Until you've fully developed your own ironclad lease option contract, it's imperative that you work with an experienced real estate attorney in your state that is knowledgeable about lease options.
Today, multiyear option contracts are the norm to allow people with foreclosures or other credit damage to improve their credit scores to qualify for a mortgage. Here are some things you need to know about that issue.
Tip #1. Not all buyer/tenants make the same level of effort to improve their credit score. A two or three year purchase option should have an annual review clause. The buyer/tenant credit score should be a review point.
Let's say their score was 605 at the beginning of the lease. At the one-year point, the lease option holder should expect the score to have increased to 650 or something close. If that score is not met, the clause allows the contract to be terminated so that the lease option holder can bring in a new buyer willing to put in the effort to qualify for a mortgage. If necessary, use a shorter lease option deadline for the new buyer that stays within your own lease option period of time.
Tip #2. If you are already in a lease option but didn't notarize and record it as a public record with the county, you can still sign and file a "memorandum of option" affidavit. While this isn't foolproof documentation should the property owner try to sell the property to someone else but it does cloud the title and will raise the question if he has a clean title.
Tip #3. Although you are encouraging the buyer/tenant to act as a responsible homeowner, you don't want them responsible for the taxes and insurance. If you ever need to evict the tenant, having them pay taxes and insurance could convince a judge that you have a buyer-seller relationship rather than a landlord-tenant relationship.
Tip #4. Looking for great tenant/buyers? Establish a relationship with a couple of corporate relocation offices. They will refer clients that want to buy at their new corporate location but can't do it until they sell their previous home. These people are likely to qualify for a mortgage immediately after their prior home sells.
Tip #5. How major repairs are handled according to the contract can create a sticky issue if something costly needs to be repaired or replaced. A typical contract will state that the tenant/buyer is responsible for all repairs up to a specific dollar limit, say $10,000. Anything above that, you, as the lease option holder are responsible for. However, situations can easily come up that bring this contract clause into question.
Maybe a windstorm does significant damage to the roof. The tenant/buyer is convinced the entire rook needs to be replaced at a cost of $20,000. You, as the lease option holder, know it can be repaired for $8,000. How are you going to resolve this big difference without doing damage to the business relationship?
The answer is maintaining a high quality catastrophic insurance policy on the house. The repair/replace decision falls to the insurance adjustor. Since you are the policyholder, your role becomes being a strong advocate for the solution the tenant/buyer prefers. You can also take out a home warranty covering major appliances and heating/cooling systems.
Whether you are a novice or highly experienced investor, you can always improve your lease option contract clauses.
Author bio: Brian Kline has been investing in real estate for more than 30 years and writing about real estate investing for seven years. He also draws upon 25 plus years of business experience including 12 years as a manager at Boeing Aircraft Company. Brian currently lives at Lake Cushman, Washington. A vacation destination, a few short miles from a national forest in the Olympic Mountains with the Pacific Ocean a couple of miles in the opposite direction.