A lease option (also called a "lease with an option to purchase ") is a lease combined with an option to purchase the property within a specified period, usually 3 years or less, at an agreed-upon price. The borrower pays an option consideration fee, normally 1% to 5% of the price, which is credited to the purchase price. The borrower pays rent, and an additional rent premium that is also credited to the purchase price. If the purchase option is not exercised, the buyer loses both the option fee and the rent premium.

Using a Lease Option

The lease option offers homeownership opportunities to consumers with little cash and/or poor credit, who are prepared to bet on themselves. The bet is that before the option period expires, they will qualify for the mortgage they need to exercise the purchase option. During the option period, they have the opportunity to rebuild their credit and accumulate equity while living in the house.

The development of the sub-prime market, in which consumers with poor credit or no cash can obtain loans, does not seem to have lessened interest in lease option. It is very likely that those who succeed in exercising their option under a lease option do better than if they had financed a conventional purchase in the sub-prime market. The savings in finance costs will more than offset a higher price on the house. But those who can’t exercise their option will lose their bets.

Consumers who need to rebuild their credit rating during the option period should understand that paying their rent on time won’t do it. Rent payment information is not used in compiling credit scores. While Fair Isaac, the company that developed credit scoring, has recently unveiled an “expansion” score based on “non-traditional credit data,” it does not yet include rent payment information from individual home owners. Lease option buyers who need a higher credit score must focus on their credit cards and loans. Even though it is costly, the right not to exercise the option is of value to buyers. If there is something seriously wrong with the house, neighborhood, or neighbors, the money left behind on a lease option is much smaller than the cost of an outright purchase followed by a sale.

Advantages for Buyers

• Small Amount of Up-Front Cash Required The amount of up-front cash required to acquire a home or other property on a lease-option is usually small, often just a few thousand dollars for the first month's rent plus non-refundable option consideration. This option money is in lieu of a security deposit.
• Monthly Rent Credit Builds a Down Payment The unique characteristic of a lease-option is the rent credit toward the buyer's down payment. Typically, the rent credit is 10 to 100 percent of the monthly rent, depending on how motivated the seller is to sell. The higher the rent credit percentage, the greater the probability the tenant will buy.
• Try Out the Property Before Buying Another special lease-option benefit for the tenant is the ability to try out the property before buying. If it is undesirable, the tenant hasn't tied up a large amount of cash in a home that might be difficult to resell.
• Control Property With Very Little Cash The ability to control a property and profit from its market value appreciation with very little cash is called leverage. Lease-option buyers have this unique advantage.
• Longer Terms Mean Greater Profitability Although most residence lease-options are for short terms, such as one or two years, smart investors seek lease-options with the longest possible term. They reason the property is likely to appreciate in market value over the long term.