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Is a Lease Option a Good Idea?

Posted by  on Apr 06, 2010
 

Dear Liz,

I want to buy a house and take the first time home buyer credit. I don't have a down payment, but my landlord said he'd let me buy the house with a lease option. Is this a good idea?

Meryl in Mississippi

Hi Meryl,

If you want to take the tax credit, you have to be in contract by April 30, 2010, and close on the purchase by June 30th. So you have to actually transfer ownership of the property before July 1st. Unless your lease option is set up to complete your purchase by then, there is no benefit in doing it. With most lease options, you pay an upfront fee for the option, and then pay extra rent, which is put toward your down payment. I don't recommend this for a couple of reasons.

  1. You would be committing to buying the property at today's prices. In many markets, home prices are not increasing. You could end up paying for the privilege of paying more than the home is worth by the time you are ready to close.
  2. There is no advantage to paying extra rent--lenders require that you get credit only for amounts paid over what is considered fair market rent for the property. If you just put that extra money into savings, you can earn interest, you aren't committing to a specific property, and you aren't paying an upfront fee for the option.
  3. There is a lot of fraud associated with lease options.

Some people actually make a career out of bilking tenants out of their option money, and may "sell" their homes several times a year! Here's what they do:

  1. Demand a large up-front option payment (non-refundable for any reason), and a lot of non-refundable extra rent.
  2. Sneak in the right to cancel the deal if the payment is received as few as ten days late.
  3. Demand that you make your payments in person, then make themselves impossible to find.
  4. Evict!
  5. Resell!

If you must buy with a lease option:

  1. Get a real estate attorney to protect you. There are things you must do at the start of a lease-option for mortgage lenders to credit you for your down payment.
  2. Get mortgage quotes, get pre-qualified for a mortgage, and make sure you can exercise the option by the time it expires.
  3. Put the best mortgage rates into a mortgage calculator and see if you can make the payments.
  4. If you have a "triple-net" lease, pay the taxes, home owner's dues, insurance, and other expenses. One missed payment and you're out.
  5. Maintain the property. Neglect it and your investment value drops or you may be evicted and lose your money.
  6. Never, never, never let an option expire without getting the property appraised.
  7. Make sure the contract is recorded.

Talk to the best mortgage lenders about Federal Housing Administration (FHA) or U.S. Department of Agriculture (USDA) mortgages. The down payment requirements are low (zero for USDA), qualifying is easier, and then the home can be truly yours.

Good luck, Liz



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