How to Safeguard Your Real Estate Lease Option

Lease with option to purchase is one of best ways for the home buyer with little money and not so perfect credit to actually be able to buy a home in today's tough real estate times. One of the few negative aspects of a lease option is when a seller won't live up to option contract that he agreed to. You can always sue the seller and force him to sell you the property but take it from me it can cost a lot of money in legal fees and sometimes take years to accomplish. The last one I was involved in went to arbitration and cost me an extra $50,000 and almost a year to purchase the property after my attorney gave me what I believe now was bad advice.

To keep bad things like this from happening to you here are three ways you can safeguard your lease option and purchase the property without problems and for the agreed upon price.

1. Record Your Option - Make sure you sign your option in front of a notary public and you can then record it in the public records at the county recorders office. Even if you didn't have it notarized you can still record a "memorandum of option".

You just need to sign an affidavit and then you can record it. While recording an option doesn't create a lien on the property it at least creates a "cloud" on the title which would have to be removed in order to get title insurance. It would make it difficult for the property to be sold with the cloud on it.

2. Put Your Option In An Escrow - Putting a signed deed in an escrow with a title or escrow company is a good idea. Not only will it be easier to deal with a seller who balks at transferring the property as he has already signed the deed. The main reason you use it is if for some reason the owner can't sign the deed (he died or disappeared) you just need to give the money to the escrow officer and pick up your deed.

While I have used the first two safeguards the third one is a new one on me. I found it while researching this article at the Real Estate Investors Club. It was written by William Bronchick, who is a noted real estate attorney and I included it here verbatim.

3. Record a Mortgage. "Typically a mortgage is recorded to secure payments on a promissory note. A mortgage can be recorded to secure performance of any agreement, even a purchase option. You as optionee (buyer) will now be a lien holder, in the same position as a secured lender. If the seller refuses to sell the property, you foreclose. Now the seller has to go to court to protect himself, rather than the other way around".

The above safeguards are for the buyers benefit rather than the sellers. Below you'll find safeguards for one of the problems a seller can face when a tenant/buyers defaults and won't leave like they originally agreed to do. The problem is called an equitable interest in the property. When they go to court their lawyer claims that the lease option was not a landlord/lessor and tenant/lessee relationship but rather a seller and buyer one. If they convince the judge that they are right you will have to foreclose on them rather than just evicting them. As you know foreclosures cost a lot of time and money so you need to make sure you have a lessor/lessee situation. Below you'll find tips about the things you must do to prove this in case you end in court.

1. Separate Lease & Option Agreements - Your lease agreement should be separate from the option agreement and should not mention the option at all. Be sure to use a regular lease agreement instead of a combination one.

2. Option Periods - Keep the option periods short, not more than a year at a time. If they need a longer periods, give them a right to renew at the end of each year. Each time you renew the agreement make a new lease and option agreements. You will also want to raise the rent and increase the sales price especially if you are giving an ongoing rent credit.

3. Security Deposit - Designate part of the option fee as a security deposit. This will make it look more like a lessor/lessee agreement rather than a sale.

4. Taxes and Insurance - Never let the tenants pay the taxes or insurance as it makes it look too much like a sale.

5. Rent Credits - Judges have been known to base equitable interest on the amount of equity a tenant has. Keep the rent credits small to avoid this.

6. Agreement Language - Some words that you must never use in the agreement are ones such as credit, buyer or seller. Instead use words like non-refundable option fee, lessor, lessee, landlord or tenant.

It doesn't take much to protect yourself in a lease option situation whether you are a tenant/buyer or a seller. It will be worth the extra cost to have a real estate attorney draft the agreements, especially the option one as that has the most pitfalls for the seller. Make sure you have your attorney look over any documents before you sign them and then follow the safeguards above for a smooth lease option purchase or sale.