Lease options and land contracts are mechanisms that may allow you to purchase real estate property even if you have limited funds for a down payment, or if there are negative markers in your credit history. These vehicles tend to favor the seller, though, and there are significant potential downsides. Whether you are the purchaser or the seller, consult a lawyer before signing either type of document; both are legally binding contracts.
A lease option is a rental contract that includes a provision for the renter to buy the property at the end of a set period, usually one or two years. The contract should include the selling price and should specify what portion of the monthly rent — usually a small amount — will go towards the down payment or closing costs. By contrast, a land contract is a sale agreement where the property owner holds the title and collects monthly payments, instead of a bank or mortgage company collecting them.
Advantages for the Buyer
Lease options and land contracts can be useful if you don't have the savings required for a mortgage down payment and closing costs. If your credit history is less than perfect, you might find an understanding seller who will give you a chance through a land contract. In addition, a land contract saves some of the closing costs a purchaser typically pays, such as the loan origination fee and mortgage points. A lease option lets you lock in a price and gives you time to clean up your credit record before the purchase.
Advantages for the Seller
If you're the seller, the risk to you is minimal with either option. If you lease with the option to buy and the renter decides not to purchase the property at the end of the term, you get to keep the extra money he paid towards the down payment. If you hold a land contract and the buyer defaults, you get to keep all the payments already made and you get the property back. A land contract also saves you the money and hassle of the procedures that lending companies require, such as an appraisal and a survey, as well as mortgage loan points a buyer might ask you to pay.
Neither a lease option nor a land contract involves a bank, so they lack the protections embedded in the mortgage loan process. If you are the purchaser, hire a title company to do a records search to make sure that the property is free of any liens or other legal claims before you sign any documents. Also ensure that a land contract is registered with the city or county where you live so that there is an official record.
If the owner is still making mortgage payments on the property, there are potential risks to the buyer. For example, if the mortgage includes a stipulation that the owner must occupy the property, the bank may “call the loan” and require payment in full because the owner is no longer on the premises. If the owner then is unable to pay, he will lose the property, and the purchaser could lose all the money already paid. Similarly, if a seller defaults on the mortgage for any reason, the seller loses the property to the lender, and the purchaser has no rights.
A retired federal senior executive currently working as a management consultant and communications expert, Mary Bauer has written and edited for senior U.S. government audiences, including the White House, since 1984. She holds a Master of Arts in French from George Mason University and a Bachelor of Arts in English, French and international relations from Aquinas College.