How to set up a lease with option to buy

A lease with option to buy is a lease that allows a tenant the right to purchase the property for a specific price within a certain time frame. In most lease-option situations, a portion of the rent is applied to a future down payment. Lease options are most popular among buyers who don’t have enough funds for a down payment and closing costs. Here is how you set one up:

To set up a Lease with Option to Purchase with a tenant, you need to still have all of the usual documents that you would have in a rental agreement situation (see my article here), BUT IN ADDITION, you also need to have an Option agreement that protects you as the Optionor. Many option forms available favor the Optionee.

Attached to the Option, you should also draft up a Purchase Agreement, which will spell out the terms of the sale that will allow the tenant to purchase the property. Both the landlord and tenant should initial this document to show that it was agreed to.

Since you as the landlord still own the property until the tenant pays you and takes full possession, use an Option form that is not recordable at the deeds office so that it does not get recorded against the properties public records. This will keep your title clear until you sell the property.

When you structure the Lease with Option with your tenant, be sure to charge the market rent amount. This is an area where many landlords make mistakes. Just because the tenant is planning on buying the house does not mean that they get any special treatment - they are still a tenant, the deal could fall through, and you are still responsible for the property. The Lease with Option is separate from the rental agreement.

Be sure to get a down payment from the tenants at the very beginning of the agreement. The more that your potential buyers put down up front, the less likely they will be to back out as their risk for loss is greater if they do not follow through. Credit the option fee towards the sale price if they close, and if they do not close, be sure to let them know that this fee will be non-refundable.

Additionally to protect your rights, make your option cancelable by you if the tenants default in any of the terms of the standard rental agreement.

Be sure to check into your state's laws regarding how much money you can collect from your tenants when you structure a lease with option. For example here in Michigan, a landlord can only collect 1/2 the rent amount as a security deposit and you have to give it back when the tenants move. It is common not to charge a security deposit when you structure a lease with option so that you do not have to give any money back to the tenant. It is best to apply the security deposit amount to the non-refundable option fee.

When you make a lease with option, the advantage is that you can ask for more than the current market price for your home. It is important to note though that the property will have to appraise for the purchase price you agree upon with your tenants when they go to secure a mortgage, or else your agreement will have to adjust. Take the current market price of the home and increase it by about 15% or higher to determine the selling price and account for appreciation. Remember to deduct their option fee from the final selling price.

Be sure to include a clause in your Lease with Option to purchase that makes the tenant responsible for repairs and maintenance to the property during the term of the lease with option. You want to be very clear to state in your rental agreement that the tenant is the one responsible for the cost of any repairs and renovations. As the landlord, you are still ultimately responsible to perform repairs when you rent property, and you will be the one fined and penalized by the city of repairs are not done, but often tenants will perform or arrange needed repairs under a lease option.

Finally, before you decide to make a final agreement with the tenants who are interested in potentially purchasing your property, have a loan officer do a background check on them and let you know if they will qualify for a mortgage to purchase your property. Have the loan officer advise you on how long it will take to have the tenant "mortgage ready", so that you can set your lease option term accordingly and plan to see if you even want to sell to them.

A Lease with Option can be used to produce better profits, less intense and less involved management scenarios, less headaches, and an all around solution to sell your rental property at top dollar. It also gives your tenants the ability to become home owners and allows the to take pride in the property. It truly is a win-win situation.