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.

RELATED TERMS
  1. Fixed Price Purchase Option

    The right, but not the obligation, to buy a leased item at a ...
  2. IRS Publication 527 - Residential ...

    An Internal Revenue Service (IRS) document providing tax information ...
  3. Lease Extension

    A lease extension is an agreement to extend a lease.
  4. Single Net Lease

    A single net lease is a lease agreement where the tenant covers ...
  5. Investment Property

    An investment property is a real estate property purchased with ...
  6. Renter's Insurance

    Renter's insurance is property insurance that covers a policyholder's ...
Related Articles
  1. Investing

    Rent-to-Own Homes: How the Process Works

    A rent-to-own agreement, also called a lease option or lease-to-own agreement, offers an alternative way to buy a home.
  2. Managing Wealth

    Rent-to-own homes: How the process works

    Here's what to watch for when negotiating a contract for a rent-to-own home – and who is a good candidate for this option.
  3. Investing

    Top 10 features of a profitable rental property

    Purchasing a residential rental property may sound great. But do you know what to consider when searching for the right property? Check out the following factors that can help your investment ...
  4. Taxes

    Getting U.S. Tax Deductions On Foreign Real Estate

    If your home or second home is not in the United States, you can still get U.S. tax deductions. How many and what kind depends on whether you also rent it.
  5. Investing

    How rental property depreciation works

    Rental property can prove to be a great investment. It's a bit tricky, but rental property depreciation can be a valuable tool to make your investment pay off.
  6. Taxes

    Sell Your Rental Property for a Profit

    Learn how to sell your rental property for a profit. Find out how to master the selling process.
  7. Investing

    5 Ways Rental Properties Jumpstart Your Finances

    Rental properties can help pay your mortgage, provide tax benefits and create retirement income.
  8. Managing Wealth

    When Is Leasing a Car Your Best Bet?

    Leasing a car isn't for everyone. But it's attractive for those who want low initial payments and the ability to get a new vehicle every few years.
Hot Definitions
  1. Futures Contract

    An agreement to buy or sell the underlying commodity or asset at a specific price at a future date.
  2. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  3. Portfolio

    A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, also their mutual, exchange-traded ...
  4. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  5. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  6. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
Trading Center