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A Lease Option agreement is usually two separate agreements between the parties: a Lease and an Option Agreement. The Lease Agreement is a fairly standard rental agreement. The Option Agreement is a purchase/sale agreement whereas the tenant/buyer has the exclusive right to purchase the house for a specified price and term. The price of the home may increase if the Option Agreement has a term of many months or years. The seller cannot sell the house to anyone else as long as the Option Agreement is present.
The tenant/buyer leases the house for a specific monthly rent and term. Part of the rent may or may not be applied to the purchase price. The Earnest Money Deposit (also called an option fee), price and terms of the sale are negotiated in the Option Agreement.
The Lease Agreement usually has a default clause. If the tenant/buyer does not pay the rent as agreed in the Lease Agreement, the Option Agreement is null and void, and the Earnest Money Deposit is forfeited by the tenant/buyer.
Lease Option arrangements work very well for buyers needing to improve their credit. The tenant/buyer can find a home they wish to purchase, move in, enroll their children in school and enjoy the home while rebuilding their credit. The on-time rental payments will help build the tenant/buyer's credit rating. Coaching and mentoring the tenant/buyer on methods to improve their credit is of great benefit to the Tenant/buyer, and helps to prepare for the responsibilities of home ownership.
Many lenders consider the execution of the Option Agreement as a refinance loan instead of a purchase loan. A refinance loan usually has more liberal underwriting criterion than a purchase loan. Therefore, refinance loans are easier to qualify. Also, increased equity may be considered in the loan to value calculation.
Some lenders recommend that sellers lease option a home to a tenant/buyer before carrying a mortgage for the buyer. This way the seller will have a payment history with the buyer, and proof of the buyer's ability to handle financial responsibility. Foreclosure of a mortgage is a much more difficult and lengthy process than an eviction on a lease agreement.
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