I've been reading about lease options as a way to control property without actually buying it right away. This seems like it could be a good strategy for someone like me who doesn't have a huge down payment saved up yet.
Can someone explain lease options for beginners? How do you find properties where the owner is willing to do a lease option? What kind of option fee is typical, and how long do these agreements usually last?
What are the pros and cons compared to just renting or buying traditionally? I'm especially concerned about what happens if property values go down during the option period - do I lose my option fee?
Lease options can be confusing for beginners, but they're basically a two-part agreement. First, you lease the property (usually at a slightly above-market rent). Second, you get an option to buy the property at a predetermined price within a certain time frame.
You pay an option fee upfront - typically 2-5% of the purchase price. This fee is usually non-refundable, but it gets credited toward the purchase price if you exercise the option. If you don't exercise the option, you lose the fee.
The lease period is usually 1-3 years. During this time, a portion of your rent (the rent credit") might be applied toward the down payment if you buy. This varies by agreement.
Finding properties for lease options is hard. Most sellers want cash or traditional financing. You need to find motivated sellers who can't sell traditionally - maybe the property needs too much work for a bank loan, or the seller is facing foreclosure.
I did a lease option once as the buyer. It was a way to control a property while I saved up for a down payment and improved my credit. The option fee was $5,000 on a $200,000 property, and $200 of my $1,500 monthly rent went toward the purchase price.
The pros: you lock in a purchase price today. If property values go up, you benefit. You get time to improve your financial situation. You can often sublease the property (check the agreement).
The cons: if property values go down, you're stuck paying above-market price or walking away and losing your option fee. You're responsible for maintenance and repairs as if you own it. If you can't get financing when the option expires, you lose everything.
For beginners, lease options are risky. You need to be very confident you can get financing at the end of the term. And you need to do your due diligence on the property since you might end up owning it.
From an analysis perspective, lease options for beginners need careful evaluation. You need to consider:
1. Is the option price fair based on current market value and expected appreciation?
2. Can you actually qualify for financing when the option expires?
3. Is the rent credit meaningful, or is it just making the monthly payment higher?
4. What are the costs if you walk away?
I've seen lease options where the purchase price is set 20% above current market value, with the promise that it'll be worth that much in 2 years." That's speculation, not investing.
Also, watch out for lease options on properties with major issues. Some sellers use lease options to offload properties that won't pass inspection for traditional sales. Get a full inspection before signing anything, even though you're just leasing initially.