Tom Kelly: Evaluate a property by proposing a lease-option

It is often difficult to find the right cabin in a short period of time – especially for an out-of-state buyer. Although you hear about people buying “the first house we saw,” potential buyers also can spend months researching house size and style, neighborhoods, schools, churches and commute times before transacting any deal.

In a recent column, we discussed some alternative methods to finance second homes. For those who do not want to be forced to act within a tight time frame, renting or leasing with an option to buy can be a sensible alternative.

Many real estate agents know of available cabins, and renting for a year to 18 months is quite common among newcomers from out of state. Sometimes, this rental or leased cabin can turn into the permanent second home for the renters, which is why a lease with option to buy is sometimes preferable to a straight lease. A lease-option allows the vacation renters to buy time to research the area while getting a portion of the monthly rent credited toward the down payment if they decide to pursue the option. The lease agreement includes an option allowing the vacation tenant to buy the property within the lease period. Here’s how a typical lease option works.

The owner and tenant agree on a purchase price, often a figure based on today’s market value plus an estimate of the average rate of inflation (let’s use 5 percent) in the next 12 months. Let’s say the agreed upon amount is $325,000 and represents the cabin’s value 12 months down the road.

The owner charges the tenant a nonrefundable fee for the option to buy. The amount can vary, depending on how eager the seller is to move, the size and quality of the home, etc. Typically, the higher the fee, the better the tenant maintains the property. The one-time fee – let’s say it is $2,500 – is in addition to the monthly payments, and it gives the tenant the right to purchase the property for $325,000 at any time within the 12-month lease period.

The monthly rent is typically greater than market rates because no down payment has been made, but a portion of it will apply towards the down payment. The owner and tenant decide what portion will be credited. For example, if the monthly rent is $2,500, $500 of each month’s rent could be credited to the down payment.

Owners should read their mortgage agreements carefully before considering a lease-option. Some lenders may activate a “due-on-sale” clause if the borrower enters a lease-option with another party. But many times, lenders will permit a specific lease-option period if notified in advance. And, lenders are usually more willing to participate when they are assured of future business – like the seller’s or buyer’s new purchase loan.

The owner and tenant must be sure to specify both lease and sale terms in the agreement. For example, it’s a good idea to set an interest-rate ceiling in the agreement, or agree that the owner will finance the sale if conventional interest rates are at a certain level. This guards against the tenant being unable to qualify for a loan because interest rates are too high when it’s time to exercise the option to buy.

Lease-option forms are available online. If you are concerned about the language of the agreement, consult an attorney or escrow officer.

Another wrinkle to get the first crack at buying a property is an option (without the lease portion). The purchase of an option is the clearest and strongest right that can be granted that gives a potential buyer flexibility in the future. Under this plan, the buyer, or option grantee, is given the right to rent or buy a specified property during a specific period. However, the buyer, usually having paid a fee to obtain the option, is under no obligation to perform. To be enforceable, the option should set forth the price, dates and terms on which the option is exercisable.