Lease-Option Formula

Anyone on any of those questions would be a great help...

there's lots of information on lease options on this site; I'm attaching a link below from Karen who is very knowledgeable on lease options... I suggest you read these threads that provide great information

http://www.deangraziosi.com/real-estate-forums/everything-else/71370/lea...

1) I usually charge at least 5% for the option fee. The reason, they can get an FHA loan for 3.5% down and there are some conventional mtgs that will do 5% down. The interest rate will be higher but they won't have to come up with the 20% down that many mtg companies require. I do not advertise or give them a number up front when we start talking. When the subject comes up, I tell them that "We can negotiate on that. How much do you HAVE to put down?" Often they will offer more than the 5%, so you don't want to short yourself.

You are not doing them a favor to take less than 5% though. This will count toward their down pmt when they get their financing, so the larger amt will help them qualify.

Most people are aware that if they are getting a mortgage through a mtg co, that they will need 20%, so they are thrilled to be able to get into a house with this lower amt. There shouldn't be any reason that they are uncomfortable with 5% down. Just educate them.

2) You don't need a prop mgr. In a L/O they do their own maintenance. It is just like they already own the prop. But it is a good idea to make arrangements with an escrow company to take their pmts and disburse them to the present mtg co and pay taxes and ins. Makes everyone more comfortable.

3) The normal time is about 24 months which should give them time to get their credit straight but in can depend on each situation. Some houses may need a little longer if there is no equity when they first take over and may need time to develop some in order for it to appraise for the T/B to qualify for the loan.

4) Establish your price at the beginning when you first get/put the prop under contract.

5) T/Bs are usually allowed to paint/paper, put in new carpet, add landscaping or decks, etc. Your contract should stipulate that they do not make any renovations as far as removing walls, decks or landscaping already in place until they finalize everything or have gotten written authorization from the seller.

6) Yes, you base it on rent in the area. But T/Bs can often be charged a little more for a L/O property. You can also give them rental credits that could count toward their closing costs at the end. This is just another way of setting them up for success at the end. It would be a shame if a deal fell through in the end because they could not afford their closing costs.

The option fee and any extra paid on their rent goes into your pocket (does not have to be held in escrow) Be sure that your contract states that the option fee and the rent credits are nonrefundable. If the buyer decides not to move forward the money is yours to keep.

Be sure to keep very good records for when they go to get the new loan. Make copies of their option ck, etc. All banks don't know how to convert L/O deals, so you may have to call around to find one that does.

Good luck!

Karen

Thanks, Valerie. There's some great info within the link you suggested. Karen, thank you as well. Now, Karen, I do have a question stemming from your response, if you don't mind. Regarding the rent credits and deposit/option consideration, I know that takes away from the overall cost of the home when the tenant/buyer decides to exercise their option to buy so would it be like saying if the home was 100k and let's say they decide to buy after exactly 1 year and were also paying rent credits of $300/month, and their deposit/option consideration was 5k...

Example:

Value: $100,000
Option Consideration/Deposit: $5,000
Total rent credited to value after one year: $3,600

What I'm asking is after the rent credits and deposit/option consideration does the tenant/buyer try to get a loan for $91,400? Is that how it works? Even though on the purchase agreement it says the actual value of the home-in this case it would be $100,000-whenever they decide to buy do they apply for a loan for the remaining balance after whatever they've paid towards the purchase price?

You want to be careful with the terminology. The 'value' of the property and the 'purchase price' may not be the same amount.

Usually, the rent credits are to help cover closing costs, so if your asking price is $100K and they have put down $5K Option Fee, then, yes, they would apply for a loan for $95K. You just need to be careful when you are setting up the contract initially because you want to be sure that the property will appraise where it needs to so that they will be able to qualify for the loan.

Good luck!

Karen

Hello. I'm just getting started here, but one thing I do know is that everything is negotiable. All you have to do is ask for what you are able to do. If they say no, move on to the next. When it comes down to it, it is that simple. It doesn't make sense to put a offer on something that you cannot perform on. That's my 2 cents. I hope it helps a little.

I'm working on a potential lease option right now as well. I almost have it under contract. The seller has moved out of the home and they are willing to sell the home for exactly what they owe. I'm getting it for a pretty good price, I plan on doing a sandwich lease option or wholesale the lease option. I'm following the strategies in this thread and others I have been following.

New strategies are always great ways to create options to help others, that is why I love this business so much.

Good luck on your L/O! Let us know how it goes.

Mike, I know that you are a coach, but it would be great if you would fill out your bio more fully. We would like to know a little about you guys also.

Thanks!

Karen

Just to let you know that in case you run into any difficluty obtaining a cash buyers list from a realtor or real estate office, it might just be that people in CA are soooo... private about money matters. Hopefully, we can get better results in other states. Anyone who has been having positive results in other states such as Indiana, Illinois, Ohio,or New York, pls let me know by sending me a PM. Thanks very much. Don't allow the hurdles to keep you out of the race!! Success is just above our heads.

They are so great because almost anything goes, so YOU get to decide what you want it to be.

I like to build in can not pass up incentives. Also, in my deals I want the buyer to be successful in closing the deal. Good luck on that.

Help the seller get out
Then, help the buyer get in

Cheers

Now, as I get into my lease options, I'm gettin very curious as to how smooth it will go with my tenant/buyer meeting the seller if I go the route of wholesaling lease-option... My main question has to do with my assignment fee, the seller-probably not being an experienced REI-would they actually be charging their tenant 3%-5% of what they would actually sell the house for? Which has me wondering if they do that, I'd probably be getting a very small assignment fee, right? Also, if I'm doing wholesale L/Os obviously I'd let the T/B and seller know initially that I match sellers and buyers depending on the buyer's criteria, but how smoothly would it be once I collect my assignment fee that the buyer meets the seller? Let's say the seller is motivated (and I know they should always be) and they have no problem with me taking all if not a good portion of their downpayment for me finding them a T/B to occupy their property so they don't have to worry about the mortgage anymore. Would I tell the T/B that they'll need to pay the seller a little bit more money with their transaction? Or would it be as simple as just being to introduce the T/B and seller and go through their transaction process and I'm out after I get my assigment fee? Or could this happen... I tell the seller I got a qualified T/B and tell the buyer I got a home that meets thier criteria... Let's say the home is worth $100K and the seller wanted 5% for the downpayment=$5K. But they're motivated, of course, and said I can get a $3K finder's fee, and they get $2K. Could it be that I tell the T/B to pay me the full $5K and I just keep my portion and when I introduce the two of them I give the seller their $2K? Am I worrying too much? Please tell me wholesale L/Os can be that simple as the scenario I mentioned?

I'm still mind-boggled... Here's another scenario: Let's say I'm doing a sandwich L/O deal and my T/B is ready to purchase this home I got them into a year ago and on the SA we put that the home was worth $100K. If my T/B originally put down 10% as option consideration=$10K, when they go to get financing if the bank wants 20% of purchase price as a down payment would they have to put down another 10% since the originally put down a 10% option consideration, or 20% of $90K? Thanks in advance.

Sorry, I had missed your post from last week. Lots of questions... No problem. They are actually very good questions.

I don't have time right now because there is a lot to cover. Will try to come back tomorrow.

Of course, in the meantime, anyone else can certainly jump in.

Karen

Any suggestions on how to do a sandwich LO without have to put any of my own money down for down payment or monthly payments if I have LO Tenant buyers prospects?

Assuming your T/B has the option to purchase the house for $100,000 and they give you $10,000 in option money to be applied to the down payment should they decide to purchase the property...If the property appraises for $100,000 and the bank requires 20% or $20,000 down, they would need another $10,000 to get the bank loan (10,000 option money + 10,000 more cash). However, if the property goes up in value and is worth $110,000, they would need $22,000 down and the bank would be willing to loan $88,000 (80% of $110,000) on the property worth $110,000. So they owe $90,000 on the original option agreement (100,000 option price - 10,000 option money) and the bank will loan $88,000 (80% of 110,000), so they would only need to come up with $2,000 to get the bank loan and execute their option. That's the beauty of the lease option. If the price goes down, they can walk away and the only thing they lose is their option money. They are not tied to a 30 year upside down mortgage. If the property goes up, bonus, they get the increase in value.

Use your tenant/buyers money. Of course you have to have them in place ready to move in. There are several ways to make this work. Use your noggin.

Michael Mangham
Mentoring/Team Building Nationwide
MD Home Acquisitions LLC

I kind of wanted to keep those numbers as simple as possible, but I think I got it... Ok, so I'm looking into wholesaling L/Os... I know the option fee is NONREFUNDABLE. After looking over some information I see that there is also a security deposit, which is refundable if the T/B decides not to purchase. My question is even though I'd just be wholesaling should I be concerned with telling my T/B about this charge-or any of the sellers numbers and/or wishes-or just let them discuss that with the seller? Now let's say the security deposit is for real, if the T/B is late on a couple of rent payments, would they then forfeit their security deposit? Has anyone ever encountered this situation?

When you are wholesaling and assigning your assignable L/O contract YOU have already negotiated all the terms with the seller in advance. No need for the tenant buyer to be talking to the seller until AFTER you have assigned YOUR contract that you have with the seller. So seller meeting buyer should be no problem at all. There is nothing to talk about other than the terms of the contracts that A. your seller has agreed to and B. your buyer has agreed to.

When doing lease options you should always have your broker pre qualify your tenant buyer. You don't want to put someone in the seller's house that will not be capable of exercising the option. Just because they have the option payment and can pay the monthly rent does NOT qualify them. You need to watch out for the best interests of your seller. You need to do this ethically. Let the seller know that any tenant/buyer that you put in the house will be pre qualified with your broker.

Part of doing L/Os effectively is helping the tenant/buyer get a credit repair program going so that they CAN qualify for financing when the time comes. Your broker will let them know what they need to do in ADVANCE.

You also have to make it VERY clear that your tenant/buyers are buying this house. They need to want to live there and OWN the property. They will be maintaining the house just as if they owned it up until they close on it.

To me and this is just me, I now prefer to take the property "subject to" and then do the Lease Option to my tenant buyer. These deals are so few and far between I can't see flipping them. I want to make some money upfront, get a little cash flow monthly and them make some money on the back end when my tenant buyer exercises the option.

Again, this is just my business model, I don't do L/Os on upside down properties unless there is a very long option period and I pay off the mortgage when the option is exercised at the pay off amount on the closing date. So that I benefit from the mortgage pay down over the lease period, not the upside down seller.

Lots to think about and get in order. Of course FIRST you have to find the motivated seller that the numbers work on. Finding qualified tenant buyers is easy, finding the deal is hard! No property, no L/O!!

Michael Mangham
Mentoring/Team Building Nationwide
MD Home Acquisitions LLC

Is this an actual situation that you are in right now or are you just coming up with "What ifs...?"

Normally when you do a L/O there are two main situations you will find yourself in.

First one, the seller is desperate to get out from under the mortgage payment. They may or may not be behind in their pmts, but for some reason (lost job, moving out of town, already bought another house, getting married and both have houses, on and on). In this situation, you can often take over their pmts and their loan and get the house for whatever is still owed. Often, you will get a good chunk of equity. Not a penny out of your pocket. Then you turn around and find a T/B and depending on whether there is equity or not decide if a wholesale/co-op L/O or a sandwich L/O is your better strategy. In either of these, you will receive a nonrefundable option fee, which is yours to keep. In a sandwich, (if you structure it properly) you will also have some monthly cash flow and a payout in the end.

If a seller is not as "distressed" or motivated, you may not be able to work as good of a deal. Your main selling point to the seller here, will be that you can probably get them their full asking price (as long as that price is in line with current sold comps). They will not be negotiated down by the buyer and will not have to pay realtor fees. And no more pmts or maintenance. You can contract w them for full price and you will find a buyer, prescreen them and get them into a credit repair program if necessary (as Michael talks about above) and do all the paperwork. For doing this, you are paid by the T/B in the form of an Option Fee. If they want $100K for the house, your contract says that and you make up the contract to the T/B for $105K. Normally, the entire fee is yours to keep. If the seller does not go for that scenario, it can be divided in any way that is agreeable to both of you. Just be sure to keep a file with copies of all of their pmts as a paper trail for the bank making it easier for them to qualify when refiing.

There are two separate contracts between each party. One Lease with the Option to Buy and one regular Rental Agreement. In the Rental Agreement, no mention of L/o is made. The reason is, If they quit making their pmts is it much easier and cheaper to evict than to foreclose.

You also should set it up so that the T/Bs pmts are made to an Escrow Co and the Escrow Co pays the mortgage company, so that there are no problems with everything being paid and everyone is protected.

Yes, it is simple, once you understand the whole process and have PROPER contracts and have qualified everyone. This explanation is streamlined. You also have to qualify the seller's situation, etc.

Now, let me go look at your next set of questions.

Karen

If you go to a bank that requires 20% down and they (T/Bs) have already paid you 10%, if you have all the documentation, they will only need another 10% ($10K) down.

But the reason I usually ask for 5% is that they can apply for an FHA with 3.5% and there are some conventional loans that they can get with 5% down. The interest will be higher w a 5% down loan, but sometimes that is worth it.

Be careful with your terminology when talking to your Sellers and T/Bs. Above you wrote that in the SA you put "that the home was worth $100K". You want to say "the purchase price is $100K". You don't want them to be able to come back and say that you misled them just because the terminology is sloppy. I know what you meant but you need to practice saying it correctly so as not to get yourself into trouble.

Good luck!

Karen

There is not usually a security deposit more than $10.00 in a L/O situation. That is usually on paper only and never even collected.

I do not usually ever give my seller any money for a down pmt-either mine or my T/B's. They are usually just happy to be getting either out of the deal completely for what they owe or getting their full asking price when the T/B refis.

I also put into the contract that the seller continues to make the pmts until i have a T/B in place. I usually have them give me up to 90 days to find a T/B.

Remember! Everything is negotiable.

Karen

Your answers are wonderfully formatted without the presumption of knowledge. Very thorough and encompassing. "What may seem obvious to me isn't necessarily obvious to someone else."

You simply rock.

Carl

Thanks, Mike & Karen. More questions to come soon lol. Karen, I'll be sure to start saying the correct terminology so that it becomes second nature to me. I just happen to be getting tenant/buyers right now-which is going quite well might I add-and I'll start with L/O wholesaling so I want to be armed going into the negotiations, but these are all hypothetical situations, but my success stories are coming soon.

As Mike said earlier, L/os are rather reversed. Buyers are the easy part in this. The sellers--those are tough!

Karen

Ok, so a seller called me and left me a message explaining how they would like for the L/O process to go and said that they wanted to sign the sales agreement when the T/B exercises his option to buy... I didn't think this would work because, from my understanding, my T/B will have to pay an option fee at the time of signing the option agreement-which goes to me-but is a percentage of the purchase price that we agree on before they move in and allows me to get paid upfront... Please correct me if I'm wrong. But if there is a way that this all can be worked out the way the seller wants it other than the traditional way that I have been taught, please enlighten me. Thanks in advance.

With a L/O, you are leasing the property for a period of time with the option to purchase in the FUTURE.

If they are not signing until the person buying the house IS buying the house, then you just have a regular sale.

What is the seller giving you as their reason for wanting to do this? I am assuming that they are afraid the value will go up and they will lose out on it.

Karen

Karen, Mr. seller didn't give me a reason for wanting to construct the L/O deal that way, they are just a private owner trying to make sure their home is taken care of since the moved to a bigger home and can't afford two mortgages. So they don't know what we know, but I told him that I'd get back to him tomorrow... So I'm actually quite confident that I can persuade them to go for what I know... But the home was advertised For Rent, I offered a L/O in my message to him and on my voicemail he informed me how he thought it could go down when the T/B is ready to purchase.