The Lowdown on Lease Options and Owner Financing

If you ask the average person what methods are available to them for purchasing real estate, most will know about two options: taking out a mortgage or paying all-cash. Makes sense, considering these are the most commonly used methods for buying a home. However, these aren’t your only choices. You have several, actually, and the two I want to focus on today may be a bit uncommon, but they’re definitely worthy of consideration. I’m talking about seller financing and leasing to own.

How do they work?

Seller financing really isn’t that complicated. It’s a lot like taking out a mortgage, but instead of using a bank as the lender, the property owner acts in that capacity. After an agreement is made between buyer and seller, a promissory note is drawn up that details the purchase price, interest rate, payment structure and schedule, and consequences of default. The buyer then sends payments to the seller based on the terms of the loan. Many seller-financed loans are short-term (5 years or less), with a balloon payment at the end.

A lease-to-own option is similar, but there are some key differences. Like seller financing, pricing and repayment terms are agreed upon between the buyer and seller, and the buyer/renter pays the seller according to this agreement. However, the buyer also pays the seller what is called option money, which is a one-time, non-refundable fee that gives the buyer the opportunity to purchase the property after a predetermined amount of time. If they decide not to purchase, the option expires.

Who should look into leasing or seller financing?

Anyone! If you’re looking to invest in property and don’t have the capital saved up to pay cash, you’re going to need some sort of financing. Going through a bank is fine, but if you’re in a market where mortgages are hard to come by, or you don’t have perfect credit, or you’re looking for a short-term solution, then seller financing or a lease agreement might be a better option.

What are the pros and cons for the buyer?

There are several unique advantages for using these types of alternative financing, along with a couple of possible disadvantages. The pros of owner lending include a faster closing process with lower closing costs, as well as a more flexible down payment (i.e., it can be smaller because there’s no mandated minimum). In fact, the flexibility that comes with both seller financing and lease-to-own is one of the biggest benefits. Terms can be worked out however the buyer and seller want them to be, so the agreements are more or less completely customizable.

In terms of disadvantages, the biggest one with seller financing is that the buyer may have to deal with a higher interest rate than what they would get with a traditional mortgage. Sellers will typically ask for - and get - a higher rate of return because, well, they can. Even though they’re making money on the deal, in most cases, they’re doing the buyer a favor. Another disadvantage associated with both seller financing and leasing agreements is that it may be challenge even to find a seller willing to offer these options. Buyers must prove themselves as worthy borrowers, and sellers may be reluctant to strike a deal if there’s even an inkling of doubt about a buyer’s current or future financial situation.

Seller financing/leasing to own aren’t the most common ways to purchase an investment property, but they’re definitely options you have as a buyer. Before entering into an agreement with a seller, be sure to talk to a person knowledgeable in the financial and legal aspects associated with these transactions to ensure your deal is on the up and up. And remember, it’s all about your bottom line - if you’re not coming out ahead, find another strategy.