On Real Estate & More – October 2018

Qualifying for a mortgage nowadays isn’t easy. Lenders have strict requirements that weed out applicants with poor credit or too much debt or other extenuating circumstances. But there are other options that could work, depending on the willingness of both the buyer and seller, including a lease option to purchase or seller financing.

A lease option gives a buyer/tenant the opportunity to purchase a home, usually for a pre-determined and agreed-upon price, at the end of a lease period that generally lasts for several years. The landlord and tenant typically execute a lease and a sales agreement at the same time. The tenaant pays the landlord an upfront option fee for the right to purchase the home later. Some tenants also pay an additional monthly amount in addition to their rent. The landlord credits this additional payment toward the tenant’s down payment. In most cases, the tenant forfeits the option fee if he or she chooses not to exercise the option and may also lose the rent credits unless the lease states otherwise.

When seller financing is used, ownership of the property changes hands at the beginning; the buyer becomes the new owner at closing. The buyer pays the former owner (typically for several years) in a way that may look very similar to a rent-to-own transaction, but the buyer is paying off a loan after a purchase that has happened—not making rent payments.

Although a lease option is very different from seller financing, there are some similarities. In either case, the buyer might make payments to the seller until the buyer gets a loan from somewhere else (typically the buyer will apply for a loan with a bank or mortgage lender). Again, the main difference has to do with when ownership is transferred.

The timing of a change in ownership is important because each party has different risks, depending on whether or not they own the property. For example, in a lease option, buyers take a risk that the owner/landlord will fail to make their mortgage payment and lose the property through foreclosure. In that case, buyers would have been better off with seller financing (or buying the home with a traditional loan). Buyers also run the risk of the deal falling apart if they can’t make monthly payments.

With the examples above, you might assume that it’s always better to be the owner of the home, but owners also take substantial risks. Sellers have a lot at stake when they offer seller financing: if the buyer doesn’t pay (or can’t get a loan) when the loan is due, the seller may need to foreclose on the home. That means paying legal fees and evicting the buyer.

If you’re considering either of these approaches, be sure to speak with a real estate attorney to help you figure out if it’s worth the risk.