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The “Option to Purchase” Lease Addendum

If you ever have any intention of selling your unit, this is an addendum you may want to consider. While this option is usually intended for the benefit of the tenant, it can also be favorable for the landlord if local market conditions make it difficult to find qualified buyers.

There are two essential ideas behind the “purchase option:”

1. Predetermine the Purchase Price – Usually done at the time of the original lease signing, this addendum gives the tenant the right to purchase the property at a fixed price that was determined a year or two earlier. Great for the tenant if the property value increases – but chances are a landlord would generally consider this option only if the market has either been distressed or sluggish.

2. Build a Down Payment – “Purchase options” can state that a portion of the rent is to be credited toward the tenant’s down payment. In this case, rent payments are usually adjusted upward, with at least 100% or more of the adjustment credited toward the down payment. In such an instance, this down payment credit is usually required by law ~ [Check with your state or reference the American Landlord Law volume!] ~ to be kept in a separate escrow bank account, so the funds are not intermingled with your own personal funds – thereby, clearly establishing the distinction of their intended use.

Here is one example of how to build a down payment:

The monthly rent is normally $1,050 – and the option states that the tenant has the right to purchase your home at any time prior to January 1, 2010, for a purchase price of $150,000. As the landlord, you require an initial, non-refundable “option payment” of $2,000 in lieu of a security deposit – and, in addition to the monthly rent, there would be an additional option payment of $250 per month. Therefore, the total monthly payment for the tenant is $1,300 ~ $1,050 rent + $250 option to buy. All of the option money paid is non-refundable, so don’t worry about the security deposit!

You can see the advantage of this option, where it allows the tenant time (with terms of up to 24 months available) to save up for the down payment (and time to improve their credit, if needed), while – in the meantime – the purchase price remains fixed.

For example, a 24-month option on a home with a $150,000 purchase price might look like this:
• Option (in Lieu of Security Deposit): $2,000 (non-refundable)
• Monthly Option Payment (24 months @ $250): $6,000 (non-refundable)
• Total Down Payment: $8,000

This $8,000 can be applied to the purchase of the home and represents more than 5% of the purchase price of $150,000. Depending on the tenant’s credit, income and assets, this amount is usually an acceptable down payment. And, as far as the move-in expenses, the cost is about the same as moving into any other rental replaced by the option payment.

Move-in expenses example:
• First Month’s Rent: $1,300 (includes the $250 monthly option fee)
• Initial Option Fee: $2,000 (in lieu of a security deposit)
• Total Move-In Expenses: $3,300

Before completing an “Option to Purchase” agreement, it is strongly suggested that both you and the tenant contact a licensed mortgage lender to find out exactly what their underwriting requirements are for such an arrangement – especially if you intend on allowing the tenant to build a down payment or a “gift of equity.” The state of the mortgage industry has been in such turmoil of late that lenders are continually modifying their loan product matrices, terms and conditions to reduce their foreclosure risk, while – at the same time – trying to remain competitive enough to survive in the marketplace.