General Lease Option questions about Option Fee, Credit and financing

I’m trying to fully understand L/O and Sub 2 before I do my 1st deal. So, when I am paid an option fee, do I get to keep that if the tenant buys, or do I need to credit that to the sale? I’m reading a book that indicates that I get to keep that - but it kind of seems strange to me that someone would agree to pay me 10K just to have the option to buy my house.

Also, I know that I need to give sale credit on a monthly basis. What formula do you use to determine how much credit to give? Or is it a nominal amount that I determine based on how much cash flow I’m getting. Over the term of the lease, how much credit should they have to go towards the purchase?

One more: Assuming that I am going to be renting to those that are not able to get conventional financing to buy a home, how do I expect these people to get a loan after the option period is up. Am I to assume that thier FICO will be raised enough to get a convetional loan, or do I need to be able to provide them with at least 20 - 30% owner financing? Are there other options to obtain financing (assuming that I may not have enough equity in the home, or enough of my own $ to provide financing)?

Thanks so much. Please respond, it would really halp me get this straight in my head!!! Juliet

I’m also trying to understand lease-options as well and would like to know the answer! :biggrin


I always credit the option money towards the purchase price. When the t/b goes to cash you out at the end of 12 or 24 months there are lenders that will consider that to be a refinance instead of a new purchase. Just make sure that you keep a copy of the canceled checks. Also, the option money will help to fill the gap with the ltv on the new “refinance”.

With the rent credit I usually give 100-300/mo. I also give them the option to pay more now for a bigger credit. Ex) If their rent is 1000/mo and I am crediting 200/mo. I tell them that if they give me 1100/mo now I will give them a 400/mo rent credit. Money now is always worth more than money in the future. Hope that helped a little. Keep reading through all of the threads though. There is a TON of great info out there. Good Luck!! :beer

The IRS has determined that Lease Options are nothing but a Delayed or Disguised sale. "When a Lease Option is a masked land sales contract, the Tenant with a purchase Option becomes an owner of the property with equitable ownership in the property! [McClellan v Lewis, (1917) 35 CA64].

A “masked land sales contract?” What is that?

According to the IRS, a masked land sales contract occurs when, “the Tenant is in possession of the property and makes the payments, which apply in part against the purchase price, but has not yet received the deed.” In other words, if it smells like a duck, walks like a duck… Please note that they did not talk about whether the Lease Agreement was separate from the Option Agreement or, if they were dated at different times or, even that they were offered by different parties.

This determination, in my opinion, has widespread and potentially disastrous consequences for any party involved in the Lease Option process, including Home Owners, Real Estate Agents, Mortgage Brokers, Attorneys or anyone else who suggests or constructs such scheme.

Lease options are under attack. They are now illegal in Texas and several other states now have legislation pending to make them illegal, among them Colorado and Maryland. Be careful out there.

Got most of this message - but have questions about this part. Which lender are you speaking of here - the lender on the original loan that you took sub2, or the owner’s (seller’s) loan that still exisits through the lease option agreement - or a different loan? How can the tenant/buyer ‘refinance’ a loan that’s not theirs? And what does the option credit have to do with refinancing the loan? Sorry I’m so confused, but none of this has been covered in the book I’ve been reading.
By the way, I am aware that there are some legal concerns with buying Sub2, Lease Option, but I still want to know how its supposed to work. Thanks!

  1. Buy a new book. haha
  2. There are risks in every area of real estate investing. Anyone that tells you that you can buy houses “risk free” is full of it. You should run away as fast as you can from those people. This country was made on loopholes. If there is a way around it, someone will find it.
  3. The lender would be a new one.
  4. The option credit will go towards the purchase price.
    Ex) 100k house
    - 5k down
    = 95k left to finance at the end of lease
    There are plenty of lenders that will finance someone that has put 5k down on a property so this just shows proof of the down payment. Plus over the past 12 months hopefully their credit score has improved a little for them to get a better rate.
  5. Hook up with a local mortgage broker and find out what kind of programs they have for lease options. Good Luck

Nothing could be further from the truth regarding lease options being illegal. In fact, even in TX with the highly publicized legislation about lease options, they are not illegal. They require additional protections for the tenant/buyer. But you’re not going to jail if you do a lease option. Every property I own I sell via lease option. Haven’t once been sent to the big house for it. My attorney is also a real estate investor. He uses lease options, as well.
Use them, and prosper.

Texas law classifies lease/options as “executory contracts”, the same as land contracts. This is LETHAL for investors who want to keep the ownership tax benefits when selling on lease/option and taking advantage of capital gains rates. If Texas calls a lease/option an executory contract, it makes it a SALE, thus having a negative tax impact on the seller who may want to defer his gains through a 1031 exchange when the tenant exercises his option to purchase.

The bill also disallows an investor from selling a property by lease/option OR land contract if the seller has an underlying loan on the property. Since few, if any, investors have free and clear properties, this would effective ELIMINATE the process of buying a property, financing it, then reselling on a lease/option or land contract.

This hurts not just investors but ANYONE who has a house that they want to sell. Builders often sell properties on a “rent-to-own” basis, and now will be prohibited from doing so if there is underlying financing on the property. What if you do a fix-and-flip, but are unable to resell the property for cash? Maybe the lease/option would be the solution so you can cover your mortgage payments while still getting a sale? No longer possible in Texas.

The law further states that you cannot sell a property under an executory contract unless you have title to the property. That means you cannot do a sandwich lease/option in Texas - PERIOD.