The Beauty of the Lease Purchase
(for the tenant-buyer, the seller, and the investor):
Most people think of lease-purchases as a “rent-to own” situation. There are many more situations in which this technique to acquire or sell property can be used. I’ll tell you about the three most common, and how the lease-purchase can be a beautiful thing.
The Buyer: Also known as the “tenant-buyer” because they will actually rent or lease the property until they can close the sale and take title to the property. Most people that enter into a lease-purchase do so because they need to. Typically it’s someone who can’t qualify for a mortgage right away, or they have credit issues they need to clean up before they will get the best mortgage terms. Some tenant-buyers could qualify for a loan immediately, but with credit issues or job situations, they would have some pretty unattractive interest rate and fees on that mortgage. This scenario allows the buyer to get into their new home, have all of the lease and purchase and sale terms including price agreed upon, and move into their new home while repairing credit. Typically tenant-buyers can expect to pay some non-refundable earnest money on the purchase which is also called “consideration” for the terms or “option money”, and will usually pay a little premium on the rent amount and purchase price because of the terms given. A monthly credit is sometimes given to the buyer as well, and can be credited towards the down payment or closing costs. Many times these deals can be structured so that no additional “out of pocket” money is needed from the buyer to close the deal. There are also mortgage programs available and specifically designed for this situation. They allow the tenant-buyer to more easily qualify for a new mortgage after 12 current payments have been made, and allow the buyer to use the equity in the property because this type of loan is done as a refinance rather than just as a new mortgage. It’s called the lease-purchase refinance or “refi”. Nice original name, but it describes itself rather well. Lastly, this is a great way to help rebuild credit, and qualify for a better mortgage quicker, and is usually much better than just renting!
The Seller: There are a few situations when selling your home as a lease-purchase is better than just selling it outright. Here are some of them:
-If you don’t need the equity out of your current home to buy the next one,
-if you have little or no equity,
-if you’re having difficulty selling it,
-or if you just want to net a little more money, and possibly some cash flow (passive income) until it closes, but don’t want to keep it as a “rental”.
Presently in the Boise Real Estate market, we are in a “buyers market”. But we are also in an interesting time when we are experiencing what some people are calling the “mortgage meltdown”. To really summarize, too many properties nationally have been going into default and foreclosure, lots of mortgage companies have gone out of business, and many loan programs are no longer available to those with marginal credit, and low or no down payment. I have been told that approximately one-third of the potential buyers have been affected by this, and are now unable to get an attractive mortgage, or just can’t get one at all right now. Since we are experiencing a buyers market, many sellers and their Realtors are getting frustrated with the continuing price reductions, too many days on the market, too few buyers looking, and the amount of homes they are competing with. Today, the lease-purchase might be a great solution to those problems. There are usually plenty of buyers that need these terms, and even more these days with the mortgage guidelines tightening across the board. Theoretically the tenant will also take better care of the property, because they intend to buy it rather than just rent it. This is not a guarantee, but has been more often than not the case in my experience. There are pros and cons to selling your property via a lease-purchase (as with almost everything). There is also some risk involved. However, with a well written lease-purchase deal, you can mitigate the risk, set yourself up to net more money out of the sale, possibly sell quicker, and either have some cash flow until the closing, or be paying much less than you would be paying for a vacant home. Whether you’re in a “buyers” or a “sellers” market, this is a tool that can allow the seller to demand a higher sale price, above market rental rates, and have a limited term.
The Investor:
In the seller paragraph I wrote about the recent tightening of the mortgage guidelines. This is definitely affecting investors as well. In recent years there was a plethora of mortgage programs for investors buying non-owner occupied properties with as little as zero down. Today, there are almost no programs that allow investors to buy a property with less than 10% down. Furthermore, presently in the Boise
The lease-purchase can be a great tool for investors to acquire or sell residential properties. Buying a property with a lease purchase will allow you to control a property without the significant down payment required for a new mortgage. You won’t have title to it yet, but you’ll make sure you have the right to sub-lease or re-sell the property. You probably will have some non-refundable down payment required, but not the huge outlay of cash. You’ll also take on some risk, because you’ve obligated yourself to the monthly payment. Two main strategies would be to Buy and Hold, or, to Buy and Sell. On a Buy and hold, you’ll make the property a rental, with the goal of doing a lease-purchase refi (see The Buyer paragraph) to finally take title and cash out the seller by the end of your term, and continue holding the property as an investment. On a Buy and Sell, your goal would be to control the property via a lease-purchase and sell the property “subject to” you taking title. This may be after renting or sub-leasing the property for a while, selling via a second lease-purchase, or just listing & selling it. This is referred to a “subject to” sale. It is accomplished by a simultaneous closing which transfers title from the previous seller briefly to you, and then immediately to your buyer.
There are pages and pages I could write about the details and intricacies of the lease-purchase, and I’m sure there are plenty of books about it as well. My goal here is to provide a brief overview of the lease purchase, and how it can be a beautiful thing, whether you’re buying, selling, or using it as an investment vehicle.
Van States, Advantage Real Estate Team
