What are the risks of a lease option in real estate?

On Behalf of | Aug 20, 2023 | Residential Real Estate

The real estate market has been pretty wild over the last couple of years, and both buyers and sellers are currently feeling the heat from rising interest rates. That may be leading to a resurgence of lease options as a popular path toward home ownership.

A lease option is a type of rental agreement that gives the tenant the option to purchase the property at the end of their lease’s term. Generally speaking, the price for the home is fixed at the beginning of the lease, and the tenant pays either an upfront fee or a monthly premium above the usual rent for the right to purchase. In exchange, the landlord agrees not to sell the property to anybody else until the tenant’s option has passed.

Sometimes this can help would-be buyers gain some time to improve their credit scores so that they can get a mortgage. Other times, when the bank is willing to credit whatever the tenant paid above fair market rent toward the total, it can make it easier for tenants to save up the money they need for a down payment.

Lease options are not without their drawbacks

Despite the potential advantages, both landlords and tenants need to be wary of these agreements. Here are some potential problems:

  • Uncertain future property values: If property values in the area decrease during the lease period, the tenant/buyer may end up overpaying for the property. On the other hand, if property values increase significantly, the landlord/seller may feel that they were cheated out of fair market value.
  • Maintenance and repair questions: Depending on the terms of the agreement, the tenant/buyer might be responsible for maintenance and repairs during the lease term. If major repairs are needed, this could strain the tenant’s finances, especially if they are already saving to eventually purchase the property.
  • Trouble financing: Market conditions affect the willingness of lenders to offer mortgages. If the market changes significantly during the lease, the tenant/buyer may not meet the eligibility requirements for a loan.
  • Problem tenant/buyers: If a landlord/seller relies on a tenant/buyer for repairs, that can become problematic if the tenant doesn’t maintain the property very well. The buyer’s property could actually be damaged through misuse or neglect.

To mitigate these risks, it’s essential to have a well-drafted lease option that clearly outlines the terms and conditions of the agreement. If not properly drafted, there might be ambiguities or loopholes that could lead to disputes between the parties.