Chris Toth and his wife were looking to
buy their first home, two-bedroom houses
in their hometown of San Mateo, Calif.,
were going for more than $500,000.
So when their real
estate broker suggested making a
lease-option offer on a house that was
coming on the market, it seemed like a
great solution. It turned out to be just
The Toths bought their
house for $447,500, lived in it for 15
months before committing and locked in
the price 15 months before purchase. Had
they bought the home immediately without
the option, the price would have been
Had the market tanked by
20 percent in the year after the Toths
made their deal, as some were
speculating, they had the option of
backing out. They would have forfeited a
$10,000 option consideration payment,
but a steep market decline would have
cost them a lot more.
The option also gave
them time to get to know the house and
ensure they wanted it, and allowed them
time to save more money for the down
"It was perfect for us,"
said Toth, an assistant vice president
at investor relations firm FD
Morganwalke, "because we wouldn't have
been able to afford the house without
it. We wouldn't have had enough for a
Lease options are a
terrific way to buy a house for those
who are unable or unwilling to
immediately commit to a purchase.
Reasons for this could include bad
credit you need time to fix, an
uncertain work or relationship
situation, lack of a down payment or
maybe just wanting to give the house a
test drive before signing on the dotted
A lease option exists
somewhere between buying and renting.
While the specifics vary per deal, here
are the basics.
In a lease-option deal,
the renter leases the house for a
predetermined amount of time, often one
year but sometimes more. They may pay a
consideration fee up-front for the
option, plus possibly an elevated
monthly rent. If they do pay those extra
fees, the option consideration and the
amount of rent over market goes into a
fund. The buyer has the option, either
during the contract period or at the
end, to purchase the property for a
price that is usually locked in at the
time the deal was signed (although it
can contain certain provisions, such as
allowances for changes in the consumer
If the renter purchases
both the consideration and
the money paid over and above the market
rent goes toward the down payment. In
addition, sometimes a percentage of the
market rent can be credited toward the
down payment. If the renter decides not
to buy the house, the money in the fund
and the rent credits are forfeited.
Still, the potential
loss of that amount is often offset by
an increase in home value. For this
reason and others,
experts say that
lease options generally skew heavily in
favor of the renter/buyer.
"As long as the renter
doesn't pay more than market rent,
there's really very little downside to
getting an option to purchase," says
Todd Thornton, author of "Home Buying
Without the BS." "They basically build
equity without getting a loan. Plus, it
sets a price. California has 9 percent
per year appreciation. At the end of a
year, the house may be worth
substantially more than what the price
is. So you could have instant equity."
Since lease options are
skewed toward the buyer even if you are
paying slightly over market rent, they
easier to find during down real
estate markets. The current market is
strong, so a good lease option is rare.
Still, when you do find one, it's
probably out of either a seller's
desperation or just desire to get a deal
done, perhaps because the owner is
moving out of the area. So, it should be
possible to get favorable terms.
Finding a lease option
deal involves the usual home-finding
sources -- agents, brokers and ads.
While a broker would prefer an up-front
sale, since all the commission gets paid
immediately, they also realize that a
lease-option sale is better than no sale
at all. So, if you want a lease option,
talk to brokers and agents just as if
you were looking for a regular purchase.
In some cases, like for the Toths, a
seller might just take an option as
preferable to continuing to seek a
buyer, especially if the house has been
sitting empty for a bit.
And landlords can be
more flexible in other ways.
"Some landlords may skip
the credit check if they believe they
have an opportunity to sell the home at
some point in the near future," says
Thornton, since the lease option puts
cash in their hand now, even if it turns
into rental income in the long run.
Also look in the
classifieds. Someone looking to get rid
of a property may put an ad saying,
"$5,000 moves you in." As one example,
that could mean that they'll take $5,000
as the first month's rent and the option
Despite the advantages,
there are some potential pitfalls in a
lease option. As usual, safety comes
from being an informed buyer.
"Sometimes the buyer
doesn't understand the deal," says
Gerald Marsden, a CPA with Eisner &
Lubin. "Sometimes all he's getting is
the right of first refusal at a market
rate. And sometimes, the price isn't
fixed, or it's exorbitant."
There is also a danger
in the strength of current ownership, or
what the owner does during the lease
option period. An owner can take loans
out on the property during the lease
option period, clouding the potential
sale. Or, he might have already done so.
"The tenant needs to
know the quality of title that the
seller has when they enter into the
agreement," says Rick Zelman, a real
estate lawyer and senior partner with
the Miami firm of Sacher, Zelman, Van
The first step toward
protecting yourself is to have a real
estate lawyer inspect the contract.
"Problems are usually avoided by having
a good lawyer look at it," says Marsden,
"and by reading what you're signing and
understanding what it means. If you
don't understand it, sit down and do
scenarios -- what happens if. You'd be
amazed how many people make commitments
they don't understand."
In addition, Zelman
recommends taking out an ad and filing a
notice with the county record's office
alerting the world to your lease option
to protect yourself from an unscrupulous
"You want to put the
world on constructive notice in the
public record -- that's the legal term,"
says Zelman. "It's more protective than
an airtight contract. When someone
purchases property, or wants to have a
mortgage, they are legally obligated to
search the public records to see if
someone else has an interest. If the
owner sells to someone else during the
lease period, then the new buyer knows
there's someone living there who has
rights to the property."
But assuming you've
taken the steps needed to protect
yourself, the lease option can be a
great deal. The bottom line on a lease
option deal is that the option belongs
completely to the buyer -- the seller is
locked in, while the buyer is not.
As such, Thornton
recommends that lease optionees continue
to test the market, even while in the
"Just because a renter
has an option to purchase, doesn't mean
they shouldn't look around at other
homes," says Thornton. "Maybe the
purchase price in the lease option was
too high, maybe the market values have
declined, or maybe they can find a more
appropriate home based on their
Of course, as Zelman
points out, since the buyer is the one
with the option, he can always try to
renegotiate in the event of a drastic
decline in home value.
So for the smart and
careful home buyer who might not be able
to buy under normal conditions, lease
options can create a broad range of
opportunity for better value and choice
in home buying.
"The word 'option' means
renters have a choice," says Thornton.
"That's the beauty of lease options.
They don't force you to buy, but rather
give you the opportunity to buy."