Welcome to one of the most innovative gateways to home ownership ever conceived. It is a hybrid idea blending a typical rental transaction with a seller financed sale that benefits both the buyer and seller. This idea works particularly well in a challenging market where properties are not selling very briskly and financing has become difficult as we’re experiencing today.
The lease option or rent-to-own program is the ideal way to purchase a property during uncertain economic times. Due to Covid-19 and the resulting economic shutdown it has brought a lot of uncertainty to the real estate market as it has to the economy in general. It has caused lenders to greatly increase the qualifications to get a loan requiring credit scores of 680 to 700 or higher just to qualify and lending on certain property types to stop completely. In addition to being extremely difficult to obtain a loan it has created a tremendous amount of doubt regarding property values. These factors together have created a perfect storm for the real estate market. If there are willing buyers, they now question the price for a property and if they can agree on pricing with the seller it will be difficult to get the financing for it.
Most consumers are completely unaware of the power of the lease option purchase. They see this method of purchase as strictly a rent-to-own type of transaction where you pay rent with an assurance to purchase at the end of a specified term, but there is far more to it then that. The real power of the lease option lies in the structuring of the credits toward purchase and the length of term for the lease. The reason these two components are so important is that they will tremendously impact your down payment when it is time to finance this purchase conventionally at the end of the lease option term. To examine this principle in practice we will look at two hypothetical lease option situations. In the first example Owner A will be offering $1000 credit toward the purchase price from the Option Consideration or non-refundable security deposit in addition to a $100 monthly credit toward the purchase price from the Rental Fee. In the second example Owner B will be offering $500 credit toward the purchase price from the Option Consideration or non-refundable security deposit and no monthly credit toward the purchase price from the Rental Fee. In both scenarios the purchase price of the home is $150,000.00. Let us take a look at how the lease option purchase impacts the down payment in both of these examples:
Example 1: Owner A is offering $1000 from a $2000 option consideration/security deposit as a credit toward the purchase price. Additionally, Owner A is offering $100 from a monthly rental fee toward the purchase price. The impact on the transaction would look like this:
Owner A - Purchase Price - $150,000.00
Owner A - Option Consideration Credit = $1000
Owner A - Monthly Rental Fee Credit = $2400 (this is assuming a two year contract)
Owner A - amount due at time of Option Exercise (after the two year term of the contract) and financing the purchase conventionally = Original purchase price ($150,000.00) minus total of program credits ($3400.00) equals the amount to be financed ($146,600,00). By purchasing with a Lease Option you have already accumulated $3400 of equity from the program credits or 2.3% of the purchase price. If appreciation were to remain flat over the two year contract period you would only be required to put another $1850.00 down for FHA or 3.5% down payment financing. If appreciation were to go up by only 2.5% per year the value of the property which you purchased at a contract price of $150,000.00 would be worth $157,593.75. Since that accumulated equity belongs to you, the down payment you have with that equity and credits would be $10,993.75 or 7.3% of the purchase price. In addition, if there were any blemishes on your credit score you have had two years to fix them.
Example 2: Owner B is only offering $500 credit from the option consideration/security deposit as a credit toward the purchase price and nothing as a credit from the monthly rental. The impact on the transaction would look like this:
Owner B - Purchase Price - $150,000.00
Owner B - Option Consideration Credit = $500
Owner B - Monthly Rental Fee Credit = $0
Owner B - amount due at time of Option Exercise (after the two year term of the contract) and financing the purchase conventionally = Original purchase price ($150,000.00) minus total of program credits ($500.00) equals the amount to be financed ($149,500.00). By purchasing with a lease option and this minimal amount of credit you have only accumulated the $500 toward the purchase price or .3%. You would still need 3.2% for a down payment if appreciation were to remain flat as seen in the above example. The interesting thing to look at is what happens when we plug in the 2.5% appreciation as we did with Owner A. The value of the home would again be $157,593.75 with accumulated appreciation equity of $7,593.75. When we add in the Option Consideration Credit you have a total amount toward the down payment of $8093.75 or 5.4% of the purchase price and still enough to qualify at current FHA down payment requirements. Once again if there were any blemishes on your credit score you have had two years to fix them.
In both of these examples there has been a substantial amount of down payment money gained through the lease option program. That feature along with the time to repair your credit score is the power of the Lease Option and why we always try to get the highest amount of rental credits for our clients.
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