Seller financing vs. lease option - what’s the difference?

Question

What would be the pros and cons of each option? I’ve run into a scenario where a seller wasn’t willing to seller finance, but came back asking if I would consider a lease option instead.

@Steve Vaughan would you be willing to chime in? I know you have extensive experience with seller financing.

any help is appreciated, thanks everyone !

Steve Vaughan · Answer

@Brian Ellis    Thanks for the mention. Nice to be called back every now and then.

In a nutshell seller financing is selling now while a lease option is a lease that also has a separate option to buy later. Separation is key.  The tenant has a standard lease in one hand and an exclusive right to buy at a certain price for a certain amount of time in the other.  They pay for this right in the form of option consideration.  The words 'down payment' do not exist in the option world.

For instance I just did one last year and the tenant buyer exercised her option and purchased this March.  She paid $9000 for the exclusive right or option to buy for $325000 within 12 months.  I also offered an extension of an additional 6 months for a fee of $5000 but she didn't need it.

Consideration is like earnest money and goes towards the future purchase. I generally charge about 3%.   A fee is just for more time.  Both are forfeited if the option is not exercised within the term of the option given.

So yes, you collect rent.  It is a standard lease.  The option is separate.  I allow mine to be assignable.  I love these for my nicer houses  I don't plan on holding forever or houses that need work I don't want to do.  No commissions and no vacancy while you wait for your buyer to get a loan.

Joe Villeneuve · Answer

A Lease Option is a very simple complex set of two or three contracts:  1)  The Lease, 2) the Option (to buy), 3) Purchase agreement.

The lease is the lease.  Nothing different than if you were leasing the property to a tenant...and the tenant pays rent to the seller.

The Option is a contract that gives the buyer the "right" to buy the property in the future for a pre-determined price.  It is NOT a purchase agreement.  It gives the "potential" buyer the exclusive right, over a specific period of time, to buy a property.  In order to buy the property, the buyer must execute the option buy using a standard Purchase Agreement contract.

Conner Olsen · Answer

@Brian Ellis When you exercise a lease option to purchase the property you are purchasing through normal means in the future with the buyer either paying cash or getting a mortgage. In seller financing the seller becomes the bank.

Account Closed · Answer

In simple speech:

1. With owner financing you actually own the property. Your payments pay down the principal, you get deductions and appreciation.

2. With lease option you actually DON'T own the property. You have the right to buy the property sometime in the future. You pay monthly (usually) to keep that right. No principal paydown, no deductions and no appreciation. If the seller files for bankruptcy for some reason, you have to hire a lawyer to protect your rights.

It's a very big difference.

Joe Villeneuve · Answer

Keep this in mind though.  LO is actually a form of seller financing.  When most refer to Seller Financing, they are talking about the seller taking back a note on the property they are selling to you, or in other words, they are replacing a traditional lender (bank) for your financing.  The difference is this.  When you get a loan from the bank, you're actually buying cash from the bank, then spending it all (giving it to) on the property.  I've always laughed at the term "borrow".  You're not borrowing money...you're buying it.  If you were borrowing it, you wouldn't be charge interest, and you would return the same money to the one you borrowed it from when you were finished with it.  Kind of like a shovel.

When the seller replaces the bank, you're not buying cash,...you're buying equity,...one piece at a time.

Brian Ellis · Answer

Thank you for laying this all out for me! Makes a lot more sense to me now, basically less risk on my end if I can extend it out a couple years as opposed to just one year.

Dwayne Poster · Answer

The real difference is that in one case you hold title, while in the other, you hold the note.  Both typically contain a down payment and cash flow over the term. In the case of a loan, which had a balloon payment at the end of the term, they would be almost identical.

Bjorn Ahlblad · Answer

Looking forward to hearing from the Oracle!

Seller financing vs. lease option - what’s the difference?

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