What is a Lease Option
A lease option is an agreement that gives a renter the choice to purchase the rented property during or at the end of the rental period. It also precludes the owner from offering the property for sale to anyone else.
When the term expires, the renter must either exercise the option or forfeit it.
Also known as a lease with option to purchase.
BREAKING DOWN Lease Option
A lease option gives a renter or potential buyer more flexibility than a lease purchase agreement, which requires the renter to purchase the property at the end of the rental period.
The property owner may charge the renter a premium for the option to purchase the property, perhaps in the form of higher (above market value) monthly rental payments. It can also be a one-time cash payment, often called "valuable consideration," which is similar to the premium paid for an option in the financial markets. It is not a deposit on the purchase of the property so it is not refundable. The amount ranges from a token $100 to 5% of the expected purchase price.
In the contract, the property owner may opt to apply some of the higher rental fee toward the purchase price if the renter exercises the option.
The term of the option may be any period on which the property owner and renter agree, but is commonly one to three years. The lease option contract also stipulates the property's purchase price at the start of the lease or how that price will be determined at the end of the option.
Reasons to Use a Lease Option
A potential buyer may have many reasons to use a lease option rather than buy the property outright at the start. A major consideration is not having enough capital or credit to make the purchase. Renting can allow the potential buyer to save money for the purchase and at the same time build credit by making regular, on-time payments.
Even if the potential buyer has the means to purchase the property, he or she may not want to commit to it right away. For example, if the potential buyer is from another town, he or she might want to live in the new town before committing to the purchase. Or, he or she might still have their old property to sell before being able to buy the new property.
Finally, the property may not qualify for certain loans, including a VA loan, due to needed repairs or upgrades. By renting first, the potential buyer can make those improvements in order to qualify for the loan later.
A property owner may enter into a lease option agreement because they had trouble selling the house outright. The option can make the property more attractive to different types of potential buyers.
There may also be tax issues involved in selling the property outright now instead of selling it later. The option, while not a guarantee to sell later, does make it more likely that the owner has a buyer ready to go at the end of the option.