Lease Option to Purchase Overview

A lease option to purchase is one of the many types of real estate acquisition strategies that investors and homeowners may encounter. A lease option to purchase allows potential homeowners to become tenants for a set amount of time specified by the terms of a legally binding sales contract. As with other kinds of real estate transactions, they are specifically governed by the real property laws of each state.

The essential mechanics of a lease option to purchase involve a residential or commercial property, a seller who will also act as a landlord, and a buyer who also acts as a tenant. The legally binding documents used to formalize a lease option to purchase look like very intricate rental agreements, and their complexity is but one reason to retain an attorney when drafting or reviewing these contracts.

These agreements, which are sometimes called rent-to-own or lease-purchase contracts, enjoyed a certain popularity during past periods of decline in the American real estate economy. As an example, existing-home sales dropped sharply between 1978 and 1982; a time when fixed mortgage interest rates reached 17 percent. Lease option to purchase contracts became popular during this period thanks to sellers eager to get income from their properties and buyers frustrated by high interest rates. Lease purchase contracts also helped solidify the “For Sale by Owner” (FSBO) culture.

Common Elements and Structure of Contracts

Lease-purchase agreements, like any legal agreement, can be drafted to provide fairly equal protections and benefits to both parties, or they can be structured to provide greater coverage to either the buyer or seller; it largely depends on market conditions and individual financial goals. The option fee is one of the most important elements of the contract, and it is typically tacked on to the monthly rent payment. A typical option fee ranges between 1 and 5 percent of the purchase price, which is then credited to the agreed upon sales amount.

The monthly rent payment should ideally conform to the market and provide income to the seller during the option period, which can take anywhere from a few months to a few years. Sellers with short-term financial goals should keep in mind that setting short option periods in the midst of a buyers’ market could result in the tenant getting too comfortable and letting the option expire in order to look at other properties. Longer option periods are normally preferred by buyers due to the time they gain in order to fix their credit and save before closing.

The duties of buyers as tenants and of sellers as landlords must be clearly stated in the contract. Additionally, the agreement must clearly state the provisions for selling or voiding the option. As with regular real estate sales transactions, all elements of a lease option to purchase can be negotiated to the extent that state law allows.