Have you been looking into how to get into property investment? If you have, but have little or no money to invest with, you may have come across the concept of property options and lease options. In doing so, you may have realised one of the main advantages of investing with property options, but in particular with lease options. The advantage I’m referring to is they require very little money to begin investing in property.
But what is an option in property? An option in property is a contract that binds the seller to sell but does not bind the buyer to buy. Which means the buyer has an option to buy without the obligation. Whereas the seller does not have the option to sell but is obligated to do so. For an option to be legally binding consideration is required.
If you are getting into property and you don’t have much money for deposits and so on, if you can utilise a property option, combined with a lease, you are onto something quite special. The is referred to as a Lease Option or a lease with an option to purchase.
So what is a lease option? A lease option is a legal contract between a property owner and a buyer to lease or rent a property for a specific period. The option contract states that at some point between the beginning and end of the contract rental period the buyer has the option to buy the property at an agreed price, but not the obligation.
For the majority of this article I am going to focus on Lease Options in relation to residential houses. With that said, how do lease options work for residential houses?
How do lease options work for houses?
Lease options work on houses when a buyer pays the seller an amount of money (Option Fee) for a right to buy their house but without obligation, within an agreed period of time.
This right allows the buyer to buy the house at any point in the period, during which the they agree to lease the property for an agreed rent.
The lease or rent amount doesn’t have to be classed as rent in the agreement. But it can be classified as a simple reimbursement of the property owner’s mortgage payments instead.
The reason why this point in important is due to the Section 24 or Tenant Tax problem, whereby mortgage interest cannot be set against rents.
You may be asking:
- But why would someone sell their house on a lease option?
- Or why would an investor want to use a lease option?
Both are valid questions, which I cover later in this article.
What are the advantages of lease options?
The main advantage of lease options is they are little money down investments deals. Also, a lease option can be used by buyers who want to buy houses but who don’t qualify for traditional lending.
This can be because they have a bad credit rating, they’ve recently started a new business or they are new to the country.
Let’s take a look at each of these in more detail.
How to buy a property when you have a bad credit rating
One of the best ways to buy a house as an investor if you have a bad credit rating is to use lease options.
This is because you don’t need a mortgage at the point the option agreement is set up, which leaves time for your credit rating to improve until you need to exercise your option to buy the house with a mortgage.
Investing in residential houses when you’ve only just started a new business
What many property investors don’t always realise is their investment journey is made easier if they have earning income from a job or a business.
Often times beginner property investors give up their job, only to find difficulty in obtaining investment finance. This is often because many of the lenders prefer an investor to have earned income rather than just investment income.
Earned income can come from a job or from a business. The trouble is for newbie property investors is they hate their job. Which means they can’t wait to jack their job in to focus on property investment.
You are far better to wait until you have a side business. This could include a sourcing business, your own estate agency or letting agent or some other business not related to property. This opens up your options to more finance.
However, if you can’t wait to hand your notice in on your job. Or if you have already been made redundant and only just started a business, this may not be good enough for some lenders.
This is why lease options are a good idea, as you don’t need bank finance for them to work. Lease options work well if you’ve only just started your business.
Lease options work well if you are unable to seek investment finance due to being new to your country of property investment
Whenever anyone first enters a country to live they will mostly find it difficult to get bank finance. This is because they haven’t had time to build a credit report.
This problem applies to new immigrants whether they need a mortgage for themselves to get a home or for property investing.
But this same problem doesn’t arise if you buy property using a lease option, as mortgage finance isn’t required.
Do lease options work in the UK?
The combination of an option contract and a lease agreement are both legal in the UK. This solution is used by many investors in the UK to help home owners and property portfolio investors sell property fast and easy.
Do lease options work in Australia?
Lease options work in Australia for buying and investing in property.
The combination of an option contract and a lease agreement are both legal across Australia. There are many investors that use this method to help home owners and property portfolio owners in Australia to sell property fast and easy.
In fact my very first lease option contract was in Australia. I used this solution to buy 9 acres of beach-front property in Exmouth in the north part of Western Australia. I used this investment vehicle as I was struggling to get bank finance.
Do lease options work in the the US?
Lease options work in the USA for buying and investing in property.
The combination of an option contract and a lease agreement are both legal across America. Many investors use this method in the US to help home owners and property portfolio owners to sell property fast and easy.
Why would a property owner sell their house on a lease option?
There are a number of reasons why a seller would be happy to sell their house on a lease option.
Reasons why sellers are happy to sell on a lease option:
- House is in negative equity.
- Lease options are usually quicker transactions to complete compared to conveyancing contracts.
- Property landlords can mitigate their Capital Gains Tax liability. They are a very useful tool to spread the sale of their property portfolio over a number of years.
- The seller wants a higher price than the present market value of their house. But they are happy to wait for this in return for a portion of the equity now.
- Lease options offer a great opportunity for sellers to benefit from a win-win agreement with an investor.
Why would an investor use a lease option to buy a property?
There are a number of reasons why lease options work well for property investors. Some of these have already been touched upon in this article already.
Reasons why investors love to buy property on a lease option:
- Lease options require very little upfront capital to get into property investing.
- They are a great property investment vehicle if you don’t have good credit or if you are a new immigrant to the country.
- Lease options offer an extremely flexible investment tool to help home owners sell their house in difficult circumstances.
- Buying property on an option contract saves upfront Stamp Duty costs. This is because Stamp Duty isn’t payable until the option contract is exercised.
- They offer a good way to secure property at an agreed value now with the opportunity to gain as the property increases in value in the future.
- Lease options offer a great opportunity for investors to benefit from a win-win agreement with an property owners.
I hope you’ve got something from reading this article about what is an option in property
If you’ve got something from this article about “what is an option in property and is this different to a lease option” please share it on your favourite social media site.
Also, if you have any questions, please feel free to comment below too. Alternatively, if you need more help, please feel free to contact us on our contact us page here. Or join the discussion and ask your question in the property forum.