If you believe you can only buy or sell a house through a bank loan, an option to purchase is an alternative to traditional real estate.
More and more people simply don’t qualify through traditional standards, and this article outlines some seller and buyer profiles and possible solutions. During Ask Nelda (Almost) Anything, guest Sherilynn Milsom of QDHomeQuest.com outlined a few scenarios that prompt sellers and tenant buyers to seek alternatives to traditional real estate.
The dream of a home turned into a nightmare
When Ed bought his house, he decided a HELOC made the most sense in case of a rainy day. Unfortunately, the rainy days kept coming. Both Ed and his wife were laid off three times during the past five years. Then Ed’s wife became sick and couldn’t work. She didn’t have disability insurance, and Ed still hasn’t found a job. Ed doesn’t want to keep the house and stands a good chance of losing it but can’t sell it through a realtor because there is very little equity. Selling it would put Ed underwater. He’s in between a rock and a hard place. What can he do?
When Fred and Martha married, they bought the house of their dreams. Two years later, the marriage ended, and Martha moved out. The mortgage is eating up Fred’s entire paycheck. Fred found a job in another city and wants to move and sell the house. He wants a clean break. What can he do?
Lisa loves pets and has always lived with three dogs and at least two cats. It’s time to sell and downsize but the logistics of removing her pets and vacuuming three times a day while strangers traipse in and out of her house turns her stomach. She’s recently widowed, wants to move to a senior facility, and hates budgeting. What can she do?
Have the money but can’t qualify for a mortgage
Manpreet is an entrepreneur with a healthy income and a great accountant who makes sure she doesn’t pay more tax than necessary. Unfortunately, her income statement doesn’t look very good to the banks, and she’s never been able to qualify for a mortgage. She’d like to buy a house but can’t figure out how.
Katia is a newcomer to Canada who came with a healthy nest egg and an employment contract. She can afford a house now, but the banks tell her she’d have to wait another three years to qualify for a mortgage. She doesn’t want to wait that long.
Eric declared bankruptcy two years ago. Since then, he’s managed to get his finances back on track and has saved up $30,000 for a home, but the banks won’t look at him for at least five years. He wants to buy a house now. How can he do it?
Jamie and her husband had a contentious relationship, and she filed for a divorce. Her husband controlled the finances in the relationship, and as a parting gift, he ruined her credit. Even though she has a good job and savings, she would never qualify for a mortgage because of her current horrible credit. Shed would like her son to grow up in a nice house in a nice neighbourhood. What can she do?
Luckily, a bank mortgage isn’t the only way to buy a house. There is another option. Literally. It’s called option to purchase.
Here’s how it works:
An option to purchase is a financial arrangement where an investor acquires the right to buy a property sometime in the future. It involves two components; a lease and an option to purchase.
The investor interviews you to understand what your want in a property and finds a house that fits your specifications.
The investor then acquires the right to buy that property through an option to purchase.
- You move into the house as a tenant, sign a residential rental lease, and pay a non-refundable option to the purchase price. Depending on the price of the house, and what you and the investor negotiate, the option to purchase can range from thousands of dollars to a percentage of the house price.
- The option to purchase contract outlines when and how the home’s purchase price is determined and the date they can exercise the option to purchase.
- Typically rent is higher than the regular market rate since an option to purchase must address the tenant’s price for the rental property in the future.
- In addition to the rent, the price can include taxes and interest on the loan amount. Depending on the contract terms, you may also be responsible for maintaining the property and paying for repairs.
- When the contract ends, you have the option to buy the property either through the seller (seller financing) or by qualifying for a mortgage.
- If you decide not to buy the house, you will forfeit your option money but are not under any obligation to continue renting.
- If you still want to buy the house but need more time to save for the down payment – you can renegotiate the terms with seller financing.
- If you choose to buy the house, you exercise your option, buy the property, and the investor deducts the option fee from the house sale price.
- Depending on the terms of the contract, you may also exercise your option to buy the house at any time during the set date range.
The benefits to tenant/buyers are that they live in the house they want to buy now at a locked-in price based on current market rates. If the tenant’s credit score is too low to qualify for a mortgage, they can improve their credit and save up the down payment over a number of years. People with non-traditional incomes who traditional lenders may write off can buy a home and have several years to save up for a down payment. Or, they can buy early while test driving the house. Additionally, there are no processing fees.
Relocating for work, scaling down, scaling up to a better house, or moving unexpectedly may make seller financing a worthwhile alternative. Seller financing eliminates the fees banks and realtors charge and helps sellers avoid becoming poor or losing their homes or credit.
Although option to purchase contracts are common in commercial real estate, they are lesser-known in the residential real estate world.
Like all investments, it’s important to crunch the numbers first to see if the property the investor can buy with an option to purchase will provide an ROI. This involves knowing the comparative pricing of similar properties in similar areas and getting an appraisal and an inspection.
If renting to a tenant/buyer, the investor must also understand the landlord-tenant laws for specific provinces or states and have knowledge and experience with the tenant screening process.
As always, landlords, sellers, investors, and tenant buyers should do their due diligence, research the contract, the home, and the seller, and work with real estate lawyers who are experienced with option to purchase agreements.
For Manpreet, Katia, Eric, and Jamie – an option to purchase could turn their dream of homeownership into reality. For Ed and Fred, an option to purchase could move them from a rock and a hard place to a comfortable lifestyle. Lastly, for Lisa, an option to purchase could help her sell her home without all the disruption and she can negotiate for monthly payments to cover her senior facility rent rather than receiving a lump sum.
What success have you had with option to purchase? I’d love to hear about it [email protected]
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