A lease purchase agreement is a contract between the buyer and seller in a real estate transaction. Lease purchase contracts are commonly known by terms like lease option, lease with option to buy, lease purchase, LP and lease and purchase agreements.
What is a Lease Purchase Agreement?
A lease purchase (LP) is typically used in a case where a buyer wants to buy a home but for certain reasons cannot qualify for a conventional mortgage at this point in time. This can be for a variety of reasons, maybe they have credit issues that need to be resolved or need time to save for the down payment. Some buyer who are self employed may need time to establish the required employment verification and still others may need to sell an existing home before they commit to a new home.
On the other hand, lease with option to purchase contracts are ideal for sellers who need to sell their home quickly may or an investor who needs to improve his cash flow. Lease purchase arrangements are very beneficial for those who have been transferred or have lost their job and must move quickly. The immediate rental payments typically cover most if not all of the existing monthly mortgage payment and relieve a large financial burden from sellers who see themselves in this situation.
How does a Lease with Option to Buy Work?
The lease purchase agreement is basically two contracts coupled together.
The first contract is the lease or rental agreement between the parties. The buyer agrees to pay to the seller a monthly rental amount, usually an amount equal to the monthly mortgage amount for a period of 12-36 months.
The second contract is the purchase and sale agreement. It is in this contract where the terms of the eventual sale of the property are spelled out. Purchase price, closing date and other stipulations in conjunction with the transfer of ownership of the property are described and agreed upon at this time. Once the lease term is up the will have the option to exercise their rights under this agreement and purchase the property.
Components of Lease Purchase Agreement
In the past, lease purchases were traditionally seen as only beneficial to buyers in tough credit circumstances or investors who needed to flip their investments quickly, but this is no longer the case. In today’s tough mortgage market a lease purchase agreement can provide benefits for both parties.
As underwriting guidelines continue to tightened and minimum credit standards rise almost daily, many potential home buyers are being pushed out of the market and many homes are going unsold. A lease option agreement may give buyers enough time to get qualified and the seller immediate relief of a quick sale.
Typically, a lease-purchase agreement will include these features:
- A complete rental agreement outlining the lease terms and conditions.
- A complete purchase and sale agreement. This contract will contain the purchase price, the “on or before” closing date, and the other terms of the eventual sale. It is through this contract, a non-refundable “down payment” is often made from buyer to seller. This down payment will be credited to the buyers at closing but will be forfeited if the buyer either cannot close or chooses not to exercise the purchase option.
- A common feature of these agreements is a “rent to own” provision. This clause specifies that some portion of each rental payment will be credited toward the buyer’s down payment at closing. A typical example of this clause would be a monthly credit of $250 towards the buyer’s down payment. At the end of a two year lease agreement the buyer would have a total of $6,000 towards their down payment, which on a $200,000 purchase price is the 3% minimum requirement for an FHA loan.
- Another attractive feature of these types of contracts is the “As-Is” provision. The buyer agrees to accept the property in as-is condition. This clause prevents the renter from damaging the house, then asking the seller to make repairs prior to the sale. The flip side of this provision would be where a home has several cosmetic flaws, for example paint or carpet. The buyers agree to purchase the property as-is and the seller allows the cost of the repairs to be credited towards the buyer’s down payment, closing costs or purchase price at the time of closing.
Parties who desire to enter into a lease purchase agreement are encouraged to discuss the terms of the agreement with a real estate professional and their mortgage lender to ensure compliance with lender standards. If written to guidelines, some lease purchases can be treated as a refinance instead of a purchase. Mortgage refinance loan requirements are not as stringent as a conventional mortgage and will be easier for a buyer to qualify for, have less paperwork and are quicker to close.
Sellers Benefits in Lease Option Purchases
The benefits for the buyers in a lease option situation are obvious, but the sellers also obtain substantial benefits in these contracts. During the lease term the seller continues to own the property and will retain the tax benefits until such time as ownership has been transferred and the sale completed.
In addition to the tax credits, lease purchase agreements typically require the renter to be responsible for all repairs during the life of the lease and until the purchase occurs, relieving the seller of the headache of property maintenance. Sellers also typically net more at closing between the tax benefits, rental income and maintenance fees they would have had to pay if the property was to remain on the market.
Consumers can expect lease with option to purchase homes to become more of a standard as the mortgage industries attempts to regain their footing and continues to tighten credit guidelines. Other alternative financing options such as wrap-around mortgages, hard money loans and new creative financing methods are sure to become more mainstream in the coming years and even possibly a safer investment option for the wealthy, just as they were in the 80’s and 90’s.