A Down Housing Market's Upside: Lease Options

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The buyer: A potential property owner who may have suffered a setback (foreclosure, bankruptcy) or is looking to buy but doesn't want to put too much into real estate just yet.
The seller: He's trying to get rid of a nice condo in the city that he's upside down on, and needs to sell now or find another way to make that second mortgage.
The solution: A lease option.

Lease options become popular during down markets, and you're likely to find more of them available if you pay attention to local real estate ads. If you're not familiar with so-called LOs, think of them as a little more than renting and a little less than buying.

"For the leasee, they're getting a good look at the house before they buy it, like an extended test drive," says Idaho Falls, Idaho-based realtor Luke Stallings. "For the leasor, they've got someone paying rent who might buy the property and who'll likely take good care of it."

Here's how it works: The seller/landlord turns over the keys to the buyer/renter after everyone signs an agreement that requires monthly rent that's often more than the market rate over a period of time, say, two years. The new occupant has the option to buy the house at a set price at any time within the lease and a portion of the initial deposit or rent goes toward a down payment on the property.

If you, as the renter, live there two years and your circumstances change or you don't want to buy for any other reason, no harm done, although you usually do sacrifice any money you've put toward a down payment. For the seller, the lease option may give him a buyer or it may not. But what it gives him for certain is a period during which he won't have to worry about a vacant property.

"There are lots of ways to 'customize' a lease-option agreement," says Dallas attorney Rick Smith. "It can take a little while to make it work for both sides, but once you've got a good agreement everyone can live with, there's usually a happy outcome."

Here are some tips to make sure your lease option keeps you happy.

Find the house: If you're looking to go this route, talk to a Realtor who knows the neighborhoods you're shopping. They'll know the lease-option homes in that zip code and they're also likely to know which sellers who might not have thought of lease options before but who would be good to approach.

Due diligence: Unlike simply renting a home, you're signing an agreement to possibly buy it, which means you need to be thinking like a buyer. A home inspection is in order, as is a professional appraisal and, to be on the safe side, a title search. Checking out the seller is probably in order as well. You could pay that person for a few years and find out he never paid the mortgage, in which case, you're stuck without your deposit or a place to live.

Negotiate: Buyers should work with the sellers on how much money will be put into the down-payment fund, and also some basics like who should pay for improvements to the property while it's occupied. For the sellers who may be reluctant to set a price now for a home sold a few years down the road, you can add a clause that states for each six or 12 months of the lease, the price goes up a small percentage.

Get your loan going: About six months in advance of the purchase date, start the mortgage-finding process. In some cases, getting a loan in your name could be considered a refinance rather than a purchase, which is why you'll want to start the process early.

Find a lawyer: Since this is more than just a simple rental agreement, it's not a bad idea to have a professional look at the papers or help draw them up.

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