What Is a Lease Option?

Table of Contents

What Is a Lease Option?

Let me explain what a lease option really is. It's an agreement where you, as the renter, get the choice to buy the property you're renting either during the lease or at its end. This setup also stops the owner from selling it to anyone else while the option is active. If you don't exercise the option when the term ends, you forfeit it. You might hear it called a lease with option to purchase.

Key Takeaways

Here's what you need to know upfront. A lease option gives you the renter the right to buy the property. It blocks the owner from offering it for sale to others. You'll typically pay a bit more than standard rent each month, and that extra goes toward your down payment if you buy. These options can run for any length, but two to three years is common. And depending on the deal, you might handle maintenance and repairs that are usually the landlord's job.

How a Lease Option Works

You should understand that a lease option offers more flexibility than a straight lease-purchase, where you'd be forced to buy at the end. The home's price is set upfront between you and the owner, often at current market value, so you can buy it later at today's price. For this right, you usually pay an upfront fee, say 1% of the sale price, which counts toward the down payment if you go through with the purchase. This is great if you're working on your credit or saving for a down payment, but there are details to watch.

Requirements for a Lease Option

Owners face a tradeoff with lease options—they might miss out on selling at a higher price later. In return, you pay more rent than usual. The owner adds a premium to the monthly rent for your option to buy at the set price. This could be something like 10% extra on the standard rent. That premium, often called rent credit, applies to the down payment if you buy, but you lose it if you don't. Some owners take a one-time payment instead, like valuable consideration, ranging from a small fee to 5% of the purchase price—it's non-refundable, not a deposit.

Bank Financing With a Lease Option

On the financing side, banks often let the premium payments above standard rent count toward your down payment. But if the rent was market rate without a true premium, they might not credit any of it. You need to check with several banks about their policies on mortgages for lease option homes.

The Term of a Lease Option

The term can be whatever you and the owner agree on, but one to three years is typical. The contract sets the purchase price at the start or defines how it'll be calculated at the end.

Lease Option Terms

Key terms include the lease period when you occupy the property. The purchase option price is crucial—it's what you'll pay if you exercise the option, sometimes a fixed amount or based on a method like market value at termination. You pay a non-refundable option fee upfront to secure the right. Rent credits might offset costs if included. There's an exercise period where you must notify the owner of your intent to buy—miss it, and you lose the option. Default clauses outline what happens if someone breaches the agreement. Some allow extensions for a fee. Finally, an appraisal and inspection might be required to confirm value and condition, protecting you from overpaying.

Industries With Lease Options

While I focus on real estate here, lease options appear in other fields. In automobiles, you lease a car for a set time with the option to buy at the end. For equipment in manufacturing or healthcare, companies lease to test before buying. Technology involves leasing software or hardware with options to own later. Agriculture uses them for leasing farms with buy options if crops pay off. Aviation lets airlines lease planes without full upfront costs.

Tip

Consider proposing a buy option for other assets. If you've used something and it's still valuable but depreciated, the owner might agree to an easy sale if you're happy with it.

Reasons to Use a Lease Option

You and the owner might choose a lease option for various reasons— weigh if the pros beat the cons.

Why Renters Enter Into a Lease Option

If you're the renter, you might lack funds or credit to buy now. This lets you save and build credit with on-time payments. You lock in today's price against future increases. If you love the place or area, it takes the home off the market while you prepare. Even if you can afford it, you might want to test the location first or sell your old place. Or, fix up the property to qualify for loans like VA.

Why Owners Enter Into a Lease Option

As an owner, if selling is tough, this attracts buyers. You collect premium rent above market. Worst case, if they don't buy, you keep the extra and sell later. It might avoid current tax issues and lines up a likely buyer.

Important Note

Remember, you forfeit any extra rent paid if you don't exercise the option.

Lease Option vs. Right of First Offer

A lease option is like a right of first offer (ROFO), where you get first shot at buying if the owner sells. They offer terms to you first; if you pass, they shop elsewhere, but might re-offer if terms change significantly.

Lease Option vs. Right of First Refusal

It's different from a right of first refusal (ROFR), where you can match any third-party offer before the sale. ROFR triggers when the owner decides to sell, not based on time like a lease option.

Special Considerations

Include an appraisal contingency to handle value drops. Calculate exact payments to compensate the owner for taking it off market. Get a lawyer familiar with these to review the contract.

Lease-to-Own vs. Lease Purchase

Don't mix up lease option with lease purchase—the latter requires you to buy at the end.

Example of a Lease-to-Own Option

Say a home is worth $500,000 with a tenant saving to buy. Instead of market chaos, the owner offers a lease option: you pay 3-5% extra yearly as option fee, plus rent premium toward down payment. In two years, buy at today's price. It benefits both, but you risk extra costs if you don't buy, and owner misses higher offers.

How Does a Lease Option Work for a Car?

For cars, it's similar but often leads to ownership without an option—pay upfront and monthly, own at end. Cheaper than subprime loans, no credit check, but pricier than buying with good credit.

How Do You Find Lease-to-Own Homes?

Look for agents with programs, contact sellers directly, or check foreclosures for steady income streams to owners.

How Do You Write a Lease-to-Own Contract?

Use online templates, but have a lawyer review due to the financial stakes.

Does a Lease-to-Own Agreement Help Build Your Credit?

Usually not reported to credit bureaus, but ask your landlord to report payments—it can help or hurt depending on timeliness.

The Bottom Line

Lease options let owners secure buyers without listing, giving you the right to buy at a good price after paying a fee. It builds your flexibility to save and improve credit for homeownership.

What Is a Lease Option?

Highlights