Real Estate Investing Coaching - Brian Gibbons

Difference between Rent to Own and Lease with Option

It's a Rent-To-Own, Not a Lease-Option

by James Orr, http://analyzeddeals.com/

I am currently advertising one of my properties as a rent-to-own. I am trying to find someone who wants to buy the property but needs a flexible seller who will allow them to rent for a short time while they qualify for a traditional loan. I have discovered that there is a misconception that rent-to-own and lease-option are the same and that these are interchangeable terms. I disagree.

Call it semantics, but I think there is a difference even though they are similar and sometimes identical in structure.

The typical lease-option or rent-to-own involves a lease or rental agreement and an option or a purchase agreement. Aren't those basically the same? Yes, they are, but the difference, for me, is how I explain it to the tenant-buyer or lease-optionee.

If I were explaining a lease-option to the lease-optionee, I would tell them that that they are leasing the property. Any time during the option period, if they want to buy the house, they can exercise their option and purchase it for the price described in the option. Pretty good deal for them right? They can rent and, at their option, they can buy the house whenever they like.

Now, here is how I explain my rent-to-own program.

• If you were my tenant buyer, I would tell you that you are agreeing to purchase the property from me and we would have a purchase agreement to do that.
• I realize you may need some time to get your loan in place and I am willing to be flexible with you and allow you to rent while working out the details of your financing.

Can you see the subtle, yet very big difference?

• In the lease-option, they are leasing the property and if they feel like it, they can buy the property by exercising their option to buy.
• In my rent-to-own, they are agreeing to buy up front and they get the privilege of renting while they are getting their loan in place.

Usually, as a salesperson, I am reluctant to correct a buyer (think "agree and redirect"), but I am very quick to correct my tenant-buyers when they try to say they have an option to buy. No, no, no... you need to like it now and commit to me that you are going to buy.

Then, I will be flexible and let you rent-to-own the property provided that you qualify.

These are subtle differences, but they can really change the mentality of those in your property.

Is a Lease-Option a Good Idea?

Is a Lease-Option a Good Idea?

In the last few months, I have gotten a lot of inquiries about lease-options. First, let's define the term. In a lease-option, the buyer/tenant rents the property from the seller/landlord for a specified period of time. At any point during the lease, the buyer/tenant has the right to purchase the property at a price that was pre-determined in the lease-option. To compensate the seller/landlord, the buyer/tenant gives the owner a specific amount of non-refundable option money when the option is signed. In addition, the buyer/tenant usually pays above-market rent, with a certain amount to be used towards the down payment.

Let's look at an example. Fred wants to put a lease-option on Mary's house for 1 year. Fred and Mary agree that, if the purchase goes through, the price of the home will be $100,000. Fred agrees to give Mary $5,000 option money and agrees to pay $800 per month in rent, even though similar homes are renting for $500 per month. Mary agrees to allow Fred to rent the home for 1 year. At any point during that year, Mary agrees that Fred can buy her house for $100,000. In addition, Mary agrees to set aside $300 per month of Fred's rent. If Fred buys the house, this $300 per month surplus will be used as part of Fred's down payment. If Fred rents for 12 months before buying, he will have "saved" $3,600 to be used towards the purchase. If Fred decides not to buy the home, Mary keeps the extra money and Fred moves out at the end of the lease.

For the seller, a lease-option may be a way to sell a home during times when home sales are slow. But there are real advantages for the buyer as well. Especially today, when mortgage money is hard to come by, credit and income requirements are tougher, and mortgage lenders want to see more down payment money, a lease-option allows a buyer/tenant the time to work on his credit and down-payment savings, while securing the property he wants to buy now.

Other advantages for the buyer/tenant include the ability to live in the home and community before permanently committing to them. This gives the buyer/tenant the chance to try out both the house and the neighborhood to see if he really likes living there. Also, the lease-option acts as a price shield. If prices continue to fall, the buyer/tenant can walk away at the end of the lease without buying. If prices go up, the seller/landlord is locked in to the agreed upon price.

The lease-option agreement must be carefully crafted to make sure that all parties are protected and that no one is paying too much or too little for the purchase, the option money, or the monthly rent. But the biggest risk is one of foreclosure. If the seller/landlord loses the home to the bank during the option period, the tenant/buyer has no recourse other than to sue the seller/landlord. If the seller/landlord has just gone through foreclosure, chances are he doesn't have a lot of money, so even if the buyer/tenant wins, he may not be able to collect.

Before you enter into the lease-option, you can try to protect yourself by investigating what loans are presently on the property and how much the seller pays each month. If their monthly mortgage payments are much higher than the rent, the seller may have problems meeting their obligations. If you do enter into a lease-option, you may want to record it with the County Recorder. That way, if the seller tries to get another loan, the new lender will be notified of the lease-option.

Learning Rent to Own Financing - You are Lessor - Optionor

Homebuyers Are Motivated By A Dream 

It's an American dream of home ownership. Specifically we're talking about the buyers who applied for home loans but have been rejected.

They may even tried to get a loan for people with bad credit -- and still were declined.

What about those who haven't even tried to apply because they don't believe they can get a loan.

They really want to switch from throwing money away on rent to building equity and having something of their own. There are several things that are important to them that motivate then to make a transition to home ownership:

 

Pride of ownership.

Knowing that nobody can ask them to leave and sell the house from under them.

The opportunity to remodel the house to their liking.

The opportunity to tell their friends and relatives 'they bought a house' is important.
 

Because homebuyers are not profit motivated (at least not immediately), they are much less concerned with payments or price. They don't have to worry as much about making 'positive cash flow' on a house.

They're actually concerned with both price and payments, but mostly to the extent whether or not they can qualify for a loan and then afford the payments.

The most important thing for them is the fact they can buy and own the house. Therefore, our job as smart real estate investors becomes to offer such buyers that opportunity. As I mentioned before, it's an item in low supply and a relatively high demand.

Lease Options are getting more popular than ever to move houses

From a lender's point of view:

A Lease Option is considered a REFI after 12 months, not a new purchase loan.  They nickname it LEASE OPTION REFI, if the following conditions are met:

1. The borrower needs to have been in the home / condo for a minimum of 12 months.
2. The borrower needs to show proof that they have been paying rent ... PROOF = copies of cancelled rent checks.  NO, the lender will not accept confirmation of the rental from the home owner. The borrower must prove they have paid the rent on time for the last 12 months, some lenders may require 24 months. If they are more than 30 days late once, then the deal is dead (in most instances).
3. It is a full documentation transaction, so the borrower must qualify on their true income. They will have to provide pay-stubs and previous years W2 and/or tax returns and then meet the Debt-to-income requirements.         

What are the benefits?

1. If the borrower has been in the home for at least 12 months and can meet the above requirements then the lender will treat the financing as a 'REFINANCE"  What does this mean? This means that if the home appraises for $200,000.00 and the agreed upon purchase price is $160.000.00, then it is an 80% LTV loan.  The lender bases the LTV on the appraised value.  This is HUGE when it comes to getting the client qualified and lower interest rate.

Generally the Agent-Realtor needs to know that the Lease Option for 18 to 24 months (depending on he sellers comfort zone), and make the purchase time period from 12 to 18 months to give the buyer time to get their financing in order.

One thing you need to get a clear picture of is the financibility of the potential renters.

Typically the reason they want to enter into a lease option is because

1. -their income isn't high enough to qualify OR
2. they have credit issues.

Be sure that you get them qualified by a quality mortgage broker (one that is part of your TEAM) and find out if the renter could qualify for financing in 12 to 18 months.