In this post I consider some examples of rent-to-buy houses (lease options) which were provided by the people who promote them. Even these positive examples offer very little benefit to an unsophisticated ‘buyer’ in exchange for significant financial risk.
It appears that the only ‘buyers’ who have a hope of eventually owning a lease-option house are those who can afford to pay rent and put aside enough for a house deposit over 2-3 years – that is those who could own their own home without a lease option.
I have previously described some “creative property” strategies, including lease options and outlined the risks.
What is a lease option?
A lease option is combination of a lease (property rental) and an ‘option to purchase’. The ‘option to purchase’ gives the tenant the right to buy the property for an agreed amount before the end of the term of the contract (usually 2-5 years). While some people in the industry have concerns about the use of lease options, they appear to be widely used.
The tenant pays a fee for the option to purchase. The option fee is made up of an upfront “deposit” and monthly payments. The total option fee may be between $20,000 – $70,000 or more. Rent is paid in addition to the option fee. The rent amount is unlikely to be below ‘market rent’ and is often higher.
If the purchase proceeds, the option fee (or sometimes just part of the option fee) is credited towards the purchase.
Problems and Risks
The property price may be too high, or the increase in value too small, to give the tenant adequate equity to qualify for finance. Within these short periods, property values can stagnate, or even decrease.
Some of the other risks for potential “buyers” are:
- Paying an amount that often equals double rent, and paying rates and maintenance, may not be sustainable for the ‘buyer’;
- The ‘buyer’ may not be approved for mortgage finance at the end of the period, which usually means the buyer will usually lose the entire option fee paid;
- If the seller has outstanding debts, the house could be sold by creditors, and the ‘buyer’ may lose all payments made (lease options are sometimes promoted to sellers with debt problems, so it’s not unusual for “sellers” to be in financial difficulty).
The complexity of these agreements makes it easy for a seller, or intermediary, to exploit someone who hopes to own their own home. Unfair elements of contracts may include:
- above market rent (in addition to the option fee);
- high option fee (both up-front payments and monthly payments);
- only part of a large option fee may be credited towards the price of the house;
- it may be foreseeable at the time of signing the agreement that the tenant will never be able to purchase the property.
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