Monthly Archives: February 2012

What You Need to Know About Lease Options.

Typically, a lease option is when a buyer does not have the credit to finance and purchase a home so they opt to rent and call the option to purchase later.   A couple of ways to structure a lease option is to have the option available under a lease or to have the buyer purchase the property by a certain date.  It is always better for the seller to nail down the date from the buyer at the point of possession but the lease option is more common. Every situation is different so it is best to have an attorney draft the lease option to the particular terms for both parties.  A security deposit is normally required and the heftier the deposits from the tenant/optionee the better it is for the seller.  The tenant will then have a vested interest in the property and will make it more difficult for the tenant to walk away from the option. Virginia Law requires that there must be some form of consideration when doing a lease option.  The security deposit or money toward the option can be a form of consideration. The security deposit should be held by the seller and not indicated on the HUD 1 at closing.  Most of the time the security deposit is forfeited if the option is not exercised.  The time frame of the option is also very important and depending on the financial situation of the buyers, this could be a few months or up to years.  Once the option is exercised, there must be a mechanism of notice.  If the notice does not meet the requirements, it could give the seller a way out of the contract.  For an example if the property value had risen substantially while being rented.   It is also important to address the right of termination.  It is wise to have language in the option stating that if the tenant is in default of the terms that the option will terminate.

Tenants need to make sure the sellers keep the mortgage current and if the seller refinances or anyway encumber the property that the tenant is given notice. A buyer should consider having a covenant in the lease option guarding against the seller impairing the title in any way from the time that the lease option is in place.  The lease option should be recorded to provide protection for the buyer giving third parties notice of the option.  The seller would prefer the option not be recorded because it might prevent the seller from getting additional financing and might present a problem if the tenant-optionee defaults and is not willing to sign a release of the rent option.   If the lease option is for more than 5 years than it has to be in a form of a deed.  However, the lease option does not have to be recorded in order for it to be effective. Option agreements are required by Virginia Law to contain all the disclosures required for it to be binding.

There are not hard and fast rules for when the price is determined for a lease option.  The buyer normally wants the price locked down at the point of the lease and the seller would prefer the right to preserve the price to the later date especially if the lease option is for a long term. The buyer and seller can agree to obtain an appraisal at a later date to help determine the price.

In a lease option the seller is paid a monthly rent and then the purchase price once the option is exercised.  Agents can try to negotiate an upfront commission or a percentage of the monthly rent.  Unless something else is worked out in advance, the agents are paid at the end of the transaction.

In many lease options there are possession agreement.  There are two types of possession agreements.  Pre settlement possession (where the buyer takes possession before closing) and post settlement (where the seller stays beyond closing).  Several suggestions are made depending on which party is being represented.   A license agreement instead of a possession agreement is recommended when representing the seller.  This way the buyer has more of a limited authority and would not be perceived as a tenant landlord relationship.  For example; giving the buyer license to use the property to store their belongings rather than giving them possession to the property.  This gives the seller a stronger position if there is a default. A security deposit is recommended and if you are the party granting possession, it is recommended that you get as large of a deposit as you can.  Rent fees are often based on the PITI of the property and are always negotiable.  If it is a pre- settlement possession, make sure that the buyer completed a walk though before the possession and waives their rights to the walk through at closing.  If it is post possession the seller should do a waiver of claims on the buyer.  The buyer might have a provision that the seller will deliver the property in the same condition as before and remedies for any breech.

Make sure that the proper insurance policies are in place for both the property and the possessions.  It is suggested that there be an indemnity agreement where either party holds the other one harmless if there is any injury or property damage on the property while they are in possession.  It needs to be spelled out who is responsible for utilities and maintenance and the covenence of the homeowners association while having possession of the property.  There should be a provision for surrendering default that requires the party in default to surrender and pay some kind of steep penalty.  This way it will force the defaulting party to move out of the property sooner.

When buying a home that has tenants in it, the buyer should have the seller represent and warrant certain things.  For an example; that the rent payments are current, there are no defaults under the lease agreements, no rents were paid in advance, no parties are in possession that are not under written leases and that the tenants and seller are not in default in any other way.

At closing, you should get the original leases, a letter certifying that the tenants have been given notice of change the address for the rent payments, all security deposits and a pro-rated payment for that month’s rent.