SHOULD I CONSIDER A LEASE-PURCHASE OPTION?

Many of the calls we get on our listings these days are from people who want to know whether or not the seller would consider a lease-purchase on their home.  We also get frequent requests from sellers wanting to know if they should consider one.  The answer is NO…or, YES. 

First, what is a lease-purchase agreement?  It is an agreement whereby the seller would lease their property to a buyer for a period of time, at the end of which the buyer would purchase the home.  The lease and the purchase contract are both signed at the beginning of the lease period.  In effect, the seller has a tenant for a period of time, often one to two years, and collects monthly rent on the property.  Of course, the seller still owns the property, must insure it, continues to make mortgage payments, and keeps the all the  tax and other financial obligations for the property on their books, which can affect their credit worthiness, credit score, and ability to take on additional financial liabilities (i.e., a new mortgage.)  The seller is OBLIGATED to close on the sale of the home to the tenant at the end of the lease period for the price stated in the purchase contract.  However, the tenant IS NOT OBLIGATED to buy the home at the end of the lease…they can walk away, leaving the seller with a vacant and unsold property.  In exchange for this option, the seller usually either receives a large non-refundable down payment at the beginning of the lease or inflated monthly rent payments for the period of the lease, both of which would be applied to the buyer’s down payment at closing or forfeited to the seller at the end of the lease if the closing does not occur.  Many people would buy a house if they could.  They might have the monthly cash flow to make the payments, but not enough cash to cover the large down payment on an outright purchase.  Or they may have started a new job and need to build up an employment history to re-establish their credit.  Or they may have gone through a bankrupcy and cannot qualify to purchase for a certain period of time after the bankrucy’s discharge.  Their only alternative is to rent, and a lease option generally tilts in favor of the lessee/purchaser by keeping the mortgage liability off of their credit rating and delaying the closing that requires a good credit history and a large down payment at the time of purchase.

So, why should your answer be “no”?  In a lease-purchase, you, the seller, are taking on a big risk and very little guaranteed reward.  Your tenant can walk at the end of the lease, but you can’t refuse to sell at the end of the lease.  Your creditworthiness may be tied up in the house, which could prevent you from having the ability to move on and  purchase your next home, where you’ll most likely need the equity from your current home as the down payment for your next one.  You also take on all the other financial burdens of any typical lessor, as mentioned above, plus the likelihood of having to pay for repairs and damages that occur during the lease period.  We had a seller who was desparate to sell and, against our advice, signed a onne year lease-purchase agreement with a young management professional who certainly looked “safe” on paper.  However, the tenant stopped paying rent after 6 months.  The seller had to execute a normal eviction process, which typically takes at least 6 months.  The tenant ended up occupying the house for 15 months, not 12, having paid 6 months’ rent.  When the tenant was finally physically evicted by the sherriff’s office, the seller re-entered the house only to find that the tenant had done over $50,000 worth of damage to the property.  By the time repairs were made, the seller’s credit was ruined, their nerves were shot, and they still owned the house, preventing them from buying in another city where a job transfer had taken them.  The Birmgham Association of Realtors provides contracts and forms for almost any scenario in real estate transactions, but has consistently refused to provide a lease-purchase option form because of the complexities and potential liabilities of doing them.  So, overall, the best thing you can do is avoid a lease-purchase option if at all possible.

And…when should your answer be “yes”?  Probably never, if you want to buy a move-up home in the same market.  However, say you are facing foreclosure or bankrupcy unless you can get current on your mortgage payments, or you’ve taken a new job in another city and have to move.  You want, or need, to buy a home in your new location, or maybe you have ended up with two mortgages for some other reason.  You have enough cash and good enough credit to make the down payment on a second home, but you don’t want to bear the full financial burden of carrying 2 mortgages (or you have already done so, and your funds are rapidly being depleted.)  A lease-option might be your last alternative.  If you can collect some rent on your house, with a reasonable hope of selling it at the end of the lease, you might be able to offset the ongoing expenses of the home you wanted to sell, and cover your mortgage payment, taxes and insurance escrows.  At least a tenant would be paying the utilities.  And if they bail at the end of the lease, you will at least be able to keep the non-refundable down payment or inflated rental amounts you’ve collected.  (One word of caution…don’t spend the down payment or excess rent before the end of the lease term…if the tenant does go to closing with you, you will have to give it back to them to be applied as part of their down payment.)  So you might decide to go ahead with this alternative.  That’s okay, if you’re willing to assume the risk of damages, eviction, or the tenant not proceeding to close, all outlined earlier.

One other thing you should know:  If your property is listed for sale with a Real Estate Company, the commission on the sale usually will be due at the time the lease is signed, not when the purchase actually closes, so be prepared to lay out that cash obligation at the beginning of the process, not the end.  Your home will remain in MLS during the lease period or until the agreement expires as a “pending sale.”  You should check with your agent AND read your listing agreement carefully so you know what to expect.

Crawford Realty agrees with the position of the Birmingham Association of Realtors, and does not negotiate or handle the processes of negotiating and executing lease-purchase agreements.  When our sellers decide to go that route, we will refer them to an attorney who will handle all the lease and purchase documents and processes for whatever rate they charge.

Advertisement