Creative financing is simply structuring seller-financing deals with little to no money down without using traditional bank financing for real estate deals. Lease Option Investing is a creative financing strategy that real estate investors can use. Also referred to as a “Lease-to-Own,” “Rent-to-own” and/or “Lease with Option to Buy.” A lease option consists of two agreements:
Option to Purchase Agreement
These 2 agreements may be incorporated in one document or two separate documents. In a lease option agreement, the title to the property remains with the landlord until the tenant exercises his or her option and purchases the property.
In other words, the starting point of this kind of an arrangement is a tenancy, not a property purchase transaction.
The lease agreement, like any other lease, includes the duration of the lease period, the amount of rent to be paid and any repair and maintenance responsibilities of landlord and tenant.
Option to Purchase
The option agreement grants the tenant an option (right) to buy the property within a specified period of time in exchange for a fee (option fee), that is usually paid up front, and/or in the form of a higher-than-market rent (some of which is applied to the property purchase). A tenant who does not exercise the option to purchase is not entitled to a refund of the option fee or any refund in rent.
Lease Option Example
Let’s look at an example. Let’s say a seller agrees to lease a property for $800/mo with the option to buy the property within 5 years for $120,000. The seller agrees to apply $150/mo towards the purchase. Buyer pays an option fee of $3000 (applied to purchase if exercised)
Now lets say that the tenant/buyer decides to exercise his option on the 3-year anniversary for the agreed upon $120,000 price. He will have a credit for $3,000 (option fee) plus he will have accumulated another $5,400 ($150 per month for 36 months) for a total of $8,400 towards the purchase.
Now, there are a few things to consider when doing a lease option…
Option Fee – Amount:
In order to be contractually enforceable, the option to purchase must be given in exchange for consideration, or value but there is no minimum on the amount. It’s really just a matter of negotiation between landlord and tenant. Depending on factors such as the price of the property, the option fee can range from $1.00 to several thousands of dollars.
Option Fee – Non-refundable:
The tenant has no obligation to buy the property (hence – “option”) but if he or she decides not to exercise the option to purchase the property within the agreed-upon time frame, they forfeit the option money and/or any rent money that would have been applied to the purchase.
Remember, creative financing deals may be a good (or sometimes the only) option available to buyers and sellers of real estate. Real estate rules vary by state, so it is important to consult with an experienced real estate attorney to draft seller financing documents in order to allow for appropriate terms and to protect all parties involved.