Lease Option Tenant

[Shannon Elam]

I have an interested lessee to do a lease with option to buy agreement. We ran a background check with a tenant screening website on both the husband and wife. The both have credit scores between 520 and 550. Their income is greater than 2.5x the rent (I'm waiting for check stubs to see if that's net or gross) and they have no evictions. 

The do have some collections on their reports that could be a bit alarming, but the wife has informed me of her efforts to repair her credit and has even offered documentation. 

The terms of our lease option are $5000 down/$1600 per month/$200 per month towards mortgage. We settled on $5000/$1550/$100. After we dragged our feet on moving forward (waiting on a buyer) they offered me $6000/$1550/$100 to show they were serious and motivated. 

Is there anything further we should do to vet this tenant? My partner and I, unfortunately, have different opinions about the tenant's history. I think they are a good candidate. He thinks not. I don't want us to make a decision based on emotion considering that we do not have experience as landlords, yet. 

What would you do?

[Account Closed]

Originally posted by @Shannon Elam:

I have an interested lessee to do a lease with option to buy agreement. We ran a background check with a tenant screening website on both the husband and wife. The both have credit scores between 520 and 550. Their income is greater than 2.5x the rent (I'm waiting for check stubs to see if that's net or gross) and they have no evictions. 

The do have some collections on their reports that could be a bit alarming, but the wife has informed me of her efforts to repair her credit and has even offered documentation. 

The terms of our lease option are $5000 down/$1600 per month/$200 per month towards mortgage. We settled on $5000/$1550/$100. After we dragged our feet on moving forward (waiting on a buyer) they offered me $6000/$1550/$100 to show they were serious and motivated. 

Is there anything further we should do to vet this tenant? My partner and I, unfortunately, have different opinions about the tenant's history. I think they are a good candidate. He thinks not. I don't want us to make a decision based on emotion considering that we do not have experience as landlords, yet. 

What would you do?

 Shannon:

First, let's talk about your applicant. They obviously don't have great credit, but that's who ends up being interested in lease options. They're either going to have poor credit, or they will be self-employed and unable to prove income. Think about it. Someone with good credit can get a loan. And there are plenty of fairly cheap entries like FHA. People with good credit that are renters aren't going to be interested either. So you end up working usually with people with poor credit.

After doing dozens and dozens of these over the years, I quit doing them probably 6-7 years ago.  What I found is that a zebra can't change his stripes.  If they have bad credit, they have habits that caused them bad credit.  That's problematic in one of these deals.  They all start off with good intent, they're buying a house, they're excited.  In the end their habit patterns come to the fore.  If you think about it, that's the whole basis for the idea of credit reports to begin with....people do what they have always done.

All that said, I was able to work with people with poor credit.  That option money they put up helps.  Even if they get off track, the option money goes a long ways to helping while you get them out and then re-market the house.  As it turned out however, that wasn't my biggest problem with lease options.  The biggest problem had to do with repairs.  Without going into alot of detail, I consistently got houses back that had not been taken care of.  Either they didn't do the repairs at all, or the did substandard or completely incorrect repairs.  I finally decided that I would rather do the repairs myself and just rent the house.

If you're going to do them, you want to be careful about the terms you use.  It's not "down payment" or "down".  It's option money.  "Down" makes it sound like a sale.  $100 per month "toward the mortgage".  I don't know what you're talking about here, but typically you apply a monthly credit toward the purchase price, IF, and only IF, they exercise the option.  It's non-refundable.  Otherwise you're potentially creating some type of equitable sale which might need to be foreclosed.  Your paperwork is important.

What I used to do was have the tenant/buyer put up a security deposit with the lease, and then a separate option money with the option agreement.  This way, if they exercise you can just apply the security deposit to the purchase.  If they don't, you can give some of their deposit back to the extent you don't have to spent it repairing things.  And, it helps to create the idea that it is a lease with a separate option.  It also helps in case the IRS questions whether you have sold.

In recent years some states have passed legislation that would apply to lease options, so definitely check with a lawyer to find out what, if any, the rules are in your state and/or Dodd Frank.  Some states a lease option would be considered a sale, and therefore you would have to do a non-judicial foreclosure rather than an eviction.  Again, check it with a real estate lawyer.  You don't want to be foreclosing non-judicially.  In my state I can evict, and have done so more times than I care to remember without issue.

You need to have paystubs or tax returns.  2.5X isn't enough.  But that may well be net as you said.  Prior rental history is very important to check.  Do they have evictions?  Criminal background? Are their jobs stable?  As far as credit goes, I like to look at the report, not just the credit score.  I try to understand what their priorities are in terms of credit.  In other words, do they make rent a priority, and miss a credit card payment?  I'd rather see that than the other way around.

Let us know what you decide to do.