Lease option exception

10 Replies

After reading a lot about the lease option strategies, one thing I have not seen much about is an exception for home owners looking to do one or two of these a year. I understand if your are going to go into the mortgage business and begin financing people regularly, then you need to become a broker and get a license. However, reading over DF, the way I interpret it is that there is not any violation if I was to create a standard lease, then a separate option form that they can apply money to the purchase price, as well as an option fee of say 5% as long as the property is appraised and the sales price is within reason of the appraisal and they are qualified to make the payments. This would be written up by an attorney of course, but not sure what I am missing with this. 

@Pete Schmidt, your missing the purchase and sales agreement. Your need all three documents. Each stands on it's own. So in case you have to evict the process is much easier with the lease. Do not tie them together in one or mention one in the other. Do use a lawyer to draw this up and close with them if possible in your state.

Originally posted by @Ralph Newton :

@Pete Schmidt, your missing the purchase and sales agreement. Your need all three documents. Each stands on it's own. So in case you have to evict the process is much easier with the lease. Do not tie them together in one or mention one in the other. Do use a lawyer to draw this up and close with them if possible in your state.

Yes sir, I did plan to have a sales agreement and forget to mention it.  So with the 3 separate docs, and doing just 1 lease option this year, does that allow for them to apply money down to the mortgage? They want to put a large amount to the principal to lower their monthly payments.   Feel like everything I’m reading says they can’t apply any money or get credits to the purchase.  To clarify, this is a home someone will have as a primary residence, not an investment. They are on board, I am good with it, and it will be a fair deal for both parties, just need to make sure the govt. is good with it and we are not violating any laws doing so. 

Originally posted by @Ralph Newton :

@Pete Schmidt, your missing the purchase and sales agreement. Your need all three documents. Each stands on it's own. So in case you have to evict the process is much easier with the lease. Do not tie them together in one or mention one in the other. Do use a lawyer to draw this up and close with them if possible in your state.

 ..., Ralph nailed two of the most important items you missed:

1 - All three agreements must NOT refer to the other agreements, as they are all 3 separate agreements

2 - DO NOT, I repeat, DO NOT ever give credits/month towards the purchase.  There is a much better way to do the same thing, but not temp fate and get yourself screwed.

@Pete Schmidt, if I'm understanding you right you own the property and want to lease option that property to some one, becoming the bank. That being said the only reason a buyer would enter into this this arrangement is because they can't qualify for a mortgage. They lease the property until they get their credit fixed and can get a mortgage to buy you out. If they want to put a large amount of money done that's applied to the purchase agreement at time of sale thus lowering the sales price at time of signing the lease. If something changes and they can't perform on the purchase they loose all that money. Not good! As a buyer I wouldn't enter into such an agreement to begin with. If I we're you I would not go there. Keep it simple and play by the rules of lease purchase. Take a option consideration fee of an amount of 5-10% of purchase price and if they can't perform at the agreed time say two or three years you can renew the option with another fee or find a new tenant buyer. Hope that makes sense. Good luck

Originally posted by @Ralph Newton :

@Pete Schmidt, if I'm understanding you right you own the property and want to lease option that property to some one, becoming the bank. That being said the only reason a buyer would enter into this this arrangement is because they can't qualify for a mortgage. They lease the property until they get their credit fixed and can get a mortgage to buy you out. If they want to put a large amount of money done that's applied to the purchase agreement at time of sale thus lowering the sales price at time of signing the lease. If something changes and they can't perform on the purchase they loose all that money. Not good! As a buyer I wouldn't enter into such an agreement to begin with. If I we're you I would not go there. Keep it simple and play by the rules of lease purchase. Take a option consideration fee of an amount of 5-10% of purchase price and if they can't perform at the agreed time say two or three years you can renew the option with another fee or find a new tenant buyer. Hope that makes sense. Good luck

Sandwich LO are a great way to invest. Not all those that go into it are doing it because they have poor credit, although that is the #1 reason. As a REI, this is an area that you can help them. SLO can be a win/win/win for all if you truly understand what's happening.

Thanks for all the feedback guys. They are having issues getting financing since they just moved to the area and starting new jobs. However they do have a large sum of money to put down from the sale of the house they just moved out of. So I though that this may be a good solution to help them out while getting my place rented for a little bit and then sold. This being something totally new to me, I just want to make sure the I's are dotted and T's crossed. I know with 100% certainty that what I agree to will be upheld on my end and no shady business, but never know what they have planned or how they may change over the next year or two.  I understand with the keep it simple and separated and agree totally.  

@Pete Schmidt , Rent credit to sales price acts like a mortgage.  A sales agreement implies contractual agreement, and a lease option with the option payment applied to sales price - all three of these can create an equitable defendable interest in the underlying property.  The minute you sign them the tenant has an interest to defend.  Not that it will go south, but if it does you're dealing with something far more serious than a simple eviction.  

There is also a second fly in that ointment - If the IRS smells a rent to own or land contract arrangement they will interpret that "risk of loss" (the sale) happened at signing of the documents not the passing of deed (and the cash).  That eliminates the 1031 exchange as an option.

I've used lease options in the past personally (pre-Dodd Frank) and was always careful to 

1. Make the option stand alone and have no contingencies or credits the option payment was applied to.  

2. Make the lease a stand alone lease with no reference to any mortgage, sale or option at market rate.

3. Pre adjust the option price to anticipate that if they exercised the option they got credit and if they rented for x period of time they got a discount.  And at the same time wire in a strike price that anticipates whatever you want for appreciation.  If they exercise they get the benefit but there is no obligation incurred, and you can 1031.  And if they don't exercise then you are protected and all financial loss is on their side.

I love lease options.  Just be careful 

Originally posted by @Dave Foster :

@Pete Schmidt , Rent credit to sales price acts like a mortgage.  A sales agreement implies contractual agreement, and a lease option with the option payment applied to sales price - all three of these can create an equitable defendable interest in the underlying property.  The minute you sign them the tenant has an interest to defend.  Not that it will go south, but if it does you're dealing with something far more serious than a simple eviction.  

There is also a second fly in that ointment - If the IRS smells a rent to own or land contract arrangement they will interpret that "risk of loss" (the sale) happened at signing of the documents not the passing of deed (and the cash).  That eliminates the 1031 exchange as an option.

I've used lease options in the past personally (pre-Dodd Frank) and was always careful to 

1. Make the option stand alone and have no contingencies or credits the option payment was applied to.  

2. Make the lease a stand alone lease with no reference to any mortgage, sale or option at market rate.

3. Pre adjust the option price to anticipate that if they exercised the option they got credit and if they rented for x period of time they got a discount.  And at the same time wire in a strike price that anticipates whatever you want for appreciation.  If they exercise they get the benefit but there is no obligation incurred, and you can 1031.  And if they don't exercise then you are protected and all financial loss is on their side.

I love lease options.  Just be careful 

 ...and I want to vote for this post at least 20 times....but the rules say I can only vote once.

@Dave Foster explained it best @Pete Schmidt . If it looks like a duck and walks like a duck, the law will see it as a duck and will consider it a mortgage. I was in the same position that you are in when we got started with lease options over a year ago. We wanted to do the credit backs but we found out that there were predatory lawyers out there looking for real estate investors who were doing this and the lawyer would contact the renter and represent the renter in court where the investor would be fined 50k plus the tenant would be refunded 3 years rent. So we decided not to temp fate.  

We have had some renters put 30k down or 50k down as an option fee. What we do in those situations is we give them an option agreement for 30k or 50k less than the amount that we were going to create it for. We make sure though that our mortgage on the property is less the price on the option. Every time they want to put another large amount down, we create a new option agreement with a new option price. That is what we do.

Shiloh Lundahl, this is all your fault!!!  Haha  

I believe it was your BP pod cast interview I just listened to that got me into this idea. Now I see there is a lot more to it... and you made is sound nice and simple. Still sounds like a good idea, but I have a lot of learning to do. Thanks for the feed back, it is appreciated.