Percentage of Rent on Option to Buy Toward Purchase Price

What percentage of rent on an option to buy would go toward the purchase price of a property?

4 Answers

The original Lease with an Option to Purchase signed and executed by the Owner and Tenant would dictate how much of the monthly rent would apply towards the purchase.  The Lease Option might also have a provision for the initial deposit to be applies, this is offten referred to as the Lease Option Payment.

The most common structure is for the Tenant to pay a lease option up front and the Tenant has a certain number of years to execute the option.  The agreement would also stipulate how much from each month's rent will apply towards the purchase price (if anything).  When the option is executed, the amount to be applied towards the purchase is then calculated.

Unless the original lease agreement does not have these provision, none of the monthly rent can be applied towards the purchase price.  If a lease option was not signed, the only thing that can be applied is the refundable portion of the initial depsit that was agreed upon in the lease agreement.

Does the Tenant have a lease option?  What does the lease option say?

This is something that is negotiated between buyer and seller (Landlord and Tenant). When qualifying for a mortgage, most lenders will only allow the difference between market rent and the actual rent paid to be used for down payment . . . that is, the portion paid above "market rent" - though market rent in an area is likely to be a range and not a definite amount.

On a 200K  30 year mortgage at 5%, in the first 2 years, only about 23% of your payments go toward principal.

On a 200K 30 year mortgage at 7%, in the first 2 years, only about 13% of your payments go toward principal.

So, if you stay ahead of the going mortgage in percentage, you are probably in good shape.

This is entirely between the seller and the buyer; there is no set amount that would be applied to the purchase price. However, if you are paying "above market" rent, the amount per month that is "above market" would be a good guideline for the amount to be applied to the purchase price, unless you are in a seller's market, in which case it might be less (then again, in a seller's market, an option to buy is unlikely in the first place).  You'd be wise to check this with a local real estate agent because the amount could also depend on the property condition, how motivated the seller is, and what your credit profile is. Again, there's no general rule.

O a lease option, the lender is going to look at market rents in the area where the property is located.  If the allocation of rent to principal reduction is not in line with the market rents for that area, the underwriter is not going to allow the use of those funds as a down payment already made. 

For example, if the market rent for a property is $600 per month and the lease option calls for monthly payments totalling $600 per month with $200 of that total per month allocated as principal reduction, after 3 years, the lease option agreement would indicate that the leasee had contributed $7200 toward the principal reduction, which typically can be counted as down payment.

When the underwriter reviews this transaction, however, she notices that the market rent for the property is $600, not $400 as the rent allocation is established in the lease option agreement.  Most lender's guidelines will require that none of the $200 per month will count as down payment for the transaction and the borrower will have to come up with additional down payment funds to qualify for whatever particular loan he or she was attempting to receive.

The key is that when setting up the lease agreement with the purpose of allowing your leasee to obtain financing, it is important to determine what the market rent is for the property and then establish what monthly principal reduction will be made on the lease option.

I hope this helps.