Lease Option to Purchase - An Explanation Everyone Can Understand

Lease option to purchase is an alternative way to buy and sell property when the more traditional way is highly unlikely.  To some, it's a complicated and hard to understand process.  With very little effort, though, you'll find that a lease option to purchase is actually quite simple.
  • October 20 2009 - US
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A lease option to purchase simply means that a buyer can lease a property for a certain length of time (typically a year or two) and at the end of the lease they have the option to buy the property.  That's it. Rent now; buy later (if you decide to buy).

The end.

Well, not really.  Even though a lease option to purchase is easy to understand we should take a look at how one actually works.

The reason a buyer might want to consider a lease option to purchase is because they cannot qualify for a typical mortgage.  This could be because of poor credit, no money, no job, etc.  A seller might consider one if they are having a tough time selling, the market is in a down cycle, etc.

Regardless of the reason, we'll pretend that a buyer (Zack) and seller (Angie) have agreed to enter into a lease option to purchase agreement.

The first thing Angie and Zack do is figure out the details of the lease (rent) which include the monthly rent, how long the lease will last for and what utilities the buyer will be responsible for.

Angie was really looking for a one year lease. On the other hand, Zack needed at least two years because it will take him that long to improve his credit enough to allow him purchase the property.   The two finally agreed to a two-year lease at $1,500 a month and Zack would pay for all of the utilities.

With the lease portion behind them, they now had to discuss the purchase part which mainly includes the purchase price and down payment.  Of course, there are still other 'normal' contractual decisions that have to be made such as what appliances stay, is any personal property going to stay with the property, etc.

After much negotiation, Zack and Angie settled on a purchase price of $175,000 at the end of the two year lease with a $10,000 down payment, payable now.  The only problem Zack had with this agreement was he didn't have $10,000 in cash. He only had $5,200 which left him about $4,800 short.

In the end, Angie agreed to take the $5,200 in cash if Zack agreed to pay the remaining $4,800 in equal installments of $200/month for the next two years.

Zack agreed, now making his monthly payments a total of $1,700.

Fast forward 23 months.

It's been almost two years and decision day is coming.  Zack has to decide whether he wants to buy the house he's been living in for the past 23 months.  If he decides not to buy the place he forfeits the $10,000 in down payment money.

However, if he decides to purchase the property ('exercise' the option) he'll only owe $190,000. Those are his only two choices.

As it turns out, like the majority of the time, Zack didn't have a choice.  He couldn't follow through with his lease option to purchase because his credit score did not improve enough for him to qualify for regular financing.

On the last day of the lease Zack moved back in with his parents and Angie was able to put her house on the market and close sixty days later.

In summary, a lease option to purchase is an alternative way to purchase a property when regular financing is not an option.  Although some think it's a complicated process it's actually quite simple once you have a basic understanding.  In the end, most buyer do not carry through and actually purchase the property.
  • October 20 2009
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