Lease Purchase: What is it & What Are the Benefits and Risks
With a lease purchase, buyer and seller execute both a lease agreement and a purchase contract simultaneously. At the closing date, which is often simultaneous with the ending of the lease term, the buyer is obligated to purchase and the seller is obligated to sell.
Important elements of a lease purchase transactionThe lease portion of a lease purchase provides the buyer with the right to use and possess the property during the time prior to the closing of the purchase contract.When putting together a lease purchase transaction, it is important to include cross default provisions that indicate that the breach of one agreement terminates the other. If the tenant/buyer does not make the rental payments, or otherwise breaches the lease, then the landlord/seller can evict the tenant/buyer and terminate the purchase contract as well. The buyer should obtain a prequalification before the documents are executed. This lets both parties know what steps are needed in order to obtain financing for the purchase. A title report should also be obtained at the outset of the transaction in the event that there are liens and encumbrances that must be taken care of before the sale of the property.
Lease Purchase Benefits to Landlord/Seller- Landlord/Seller might get higher purchase price and higher rent.
- If tenant/buyer breaches lease, lease payments are kept by seller and seller retains their property.
- Tenant/buyers have a long term interest in the property and are more likely to take care of it.
- Landlord/Seller retains tax benefits of ownership and delays tax consequences of selling.
Lease Purchase Benefits to Tenant/Buyer- Gives tenant/buyers time to get their financials in order so that they may qualify for financing: time to create work history in new city, save up for down payment, clear credit issues, wait for own home to sell, time for money to come in from estate or settlement, time for CD's to mature, etc.
- Tenant/buyer can put money from monthly lease payment towards purchase price.
- Crediting money towards purchase price can be comforting to tenants/buyers who feel like they are working towards owning the home.
Lease Purchase Downsides/Risks to Landlord/Seller- If landlord/seller has mortgage on property, lease purchase may trigger a due on sale clause.
- Landlord/seller must wait until the lease is over to get all the money.
- If there is a mortgage, landlord/seller continues to have the debt on debt/income ratio.
- Landlord/seller continues to be responsible for HOA if the buyer/tenant does not pay or accrues penalties.
Lease Purchase Downsides/Risks to Tenant/Buyer- If unable to secure financing at end of lease term, money toward purchase credit is lost.
- If landlord/seller has mortgage on property, lease purchase may trigger due on sale clause.
- Landlord/Seller may encumber property before the tenant/buyer purchases it: mortgages, liens and judgments may attach.
- Landlord/Seller may file bankruptcy and be unable to transfer the property, and credits towards purchase are lost.
- If landlord/seller passes, the tenant/buyer may have to wait for estate to be probated.