Lease Purchase: Is This a Thing?

Written by Posted On Tuesday, 07 March 2023 00:00

One way for future buyers to come up with some down payment and buy a home of their own is through what the industry refers to as a lease-purchase. As the name implies, it’s a process whereby someone leases out a property with a pledge to purchase the property at a future date, specifically when the initial lease period is completed.

There are some mechanics that need to be worked out as well as a couple of ‘gotchas.’ How does a lease purchase actually work? It’s similar to most any ‘rent to own’ program but it has to do with real estate. The process is essentially simple. Someone signs a lease agreement and at the same time agrees to buy the property. The practice is that a portion of the lease payment is set aside to be used as a down payment when it’s time to buy. That’s pretty easy to understand. But what needs to be considered at the outset is what many might overlook.

When it’s time to officially purchase the property and buy the home with a mortgage, the set-aside funds are then used to assist with the down payment. But there are some things that need to be known.

The first is that any amount set aside for a future down payment must be above and beyond what the current rental market dictates for similar properties in the area. If the market rent for a 3-bedroom, 2-bath home is $2,500, the lease purchase part must be above and beyond $2,500. Using this example, if market rent is $2,500 and the lease portion agreed to is $3,000, then there is $500 available as the set-aside.

But those set-aside funds shouldn’t be commingled with the landlords funds. If the payment is indeed $3,000, then the extra $500 needs to be placed in a separate account. The market rent and set-aside should be evident and distinct.

And when it comes time to obtain financing, an appraisal will be ordered. The appraisal can come in the form of a simple desk review or the lender may want a full appraisal with photos. The gotcha here is what the appraised value ends up being at the end of the lease term. If the appraised value is above what similar properties are selling for, that’s something the lender wants to see. If the final appraised value falls below that amount, it’s very possible the buyers will have to come to the closing table with extra funds to cover the shortfall. 

A lease purchase can work out just fine, but getting with your loan officer well in advance of such a proposal is needed. Know in advance what to expect throughout the entire process.

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David Reed

David Reed (Austin, TX) is the author of Mortgages 101, Mortgage Confidential, Your Successful Career as a Mortgage Broker , The Real Estate Investor's Guide to Financing, Your Guide to VA Loans and Decoding the New Mortgage Market. As a Senior Loan Officer and Mortgage Executive he closed more than 2,000 mortgage loans over the course of more than 20 years in commercial and residential mortgage lending. 

He has appeared on CNN, CNBC, Fox Business, Fox and Friends and the Today In New York show. His advice has appeared in the New York Times, Parade Magazine, Washington Post and Kiplinger's as well as in newspapers and magazines throughout the country. 

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