What is a Lease-Option & When Does it Make Sense?

My aging clients told me they didn’t want to spend another winter in Park City. The home they built was in a gated community where the real estate market was slower than other parts of Park City. They had already had this home on the market for a year with another agent. My mission was to get them out of Park City by December 1st. We achieved our goal by using a Lease-Option.

In Utah we have a standard form called the “Lease Agreement with Option for Purchase”. I have successfully used this form in a few circumstances, like the example above, when it can be a win-win for buyer and seller.

First of all, what is a Lease-Option? In essence, a Lease-Option is a combination of a lease and a purchase agreement. The buyer (lessor) moves into the property and pays a lease to the seller. There is a term for the lease, usually 6-18 months. At the end of the term, the buyer/lessor can exercise his or her “option” to purchase the property and a portion of the lease payments will be applied to the purchase of the property. There is usually a security deposit that is also negotiated. During the lease period, the seller still owns the property and is responsible for repairs, taxes and HOA dues. The lessor is usually responsible for general maintenance & utilities.

The purchase part of the agreement works as follows: The buyer deposits an amount of money called “Option Money” similar to an earnest money deposit. This deposit is fully refundable during the due diligence & financing and appraisal periods. After the contingencies are removed, the deposit becomes non-refundable and may be released to the seller, depending upon the terms negotiated.

If the buyer/lessor decides to exercise his or her option to purchase the property, the Option Money and the portion of the rent negotiated are applied against the purchase of the property. If the buyer/lessor decides not to exercise his or her option, then the property goes back to the seller and the buyer/lessor forfeits the Option Money and any deposits.

This is a complicated transaction with lots of moving parts and requires REALTORS who know what they are doing. So, why would anyone enter into such an agreement? Here are real life examples that were win-win:

1. The sellers want or need to relocate. They don’t want to carry an empty house. With the lease-option, they can get enough Option Money up front to purchase a new home and the costs of their old home are carried by the lessor.
2. The buyer is going through a divorce. The buyer does not qualify to close on a purchase and/or is unable to close until the divorce is final. This buys everyone some extra time.
3. The buyer has a house to sell in another location and can not qualify for financing until their other home closes.
4. The buyer is moving from a foreign country and the currency exchange rate is at an all time low. Rather than exchanging their funds and losing tens of thousands of dollars, the lease-option buys time until the rate becomes more favorable.
5. The buyer just started their own business and can not qualify for financing until there are 2 years of tax returns.

Generally, in exchange for the favorable terms to the buyer, the seller gets a better price.

Examples of when is a lease-option not a good idea:
1. The buyer wants to “try before they buy” or is otherwise not committed to purchasing the home.
2. The buyer is never going to qualify to purchase the home because they have credit and/or income issues.
3. The seller needs to pull out all the home’s equity to move on, not just an amount equal to the Option Money.

The Lease Agreement with Option to Purchase is a great tool that Utah REALTORS have at their disposal. Like all tools, it can be useful or dangerous, depending on how it is used.