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Columns: Real Estate Adviser
Steve McLinden   Expert: Steve McLinden
Real Estate Adviser
"Buyer's remorse" over a lease-option agreement
Real Estate Adviser

Breaking a lease-option contract

Dear Steve,
A couple of years ago, my husband was transferred to another city, so we leased out our home with a purchase option. (The tenants had a poor credit rating.) Now, however, we want to get out from under the home and sell it. What should we do?
-- Babbs

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Dear Babbs,
The answer lies in the details of your signed lease-option arrangement.

For those not familiar with such deals, a lease-option renter will typically pay an extra deposit plus additional monthly rent for a set period, usually from one to three years, to amass the equivalent of a down payment.

The tenants' goal at the end of lease-option is usually to straighten out their credit enough to qualify for a mortgage to complete the purchase of the home at the set price that you and the renter initially agreed upon. Such deals are more popular in a challenging real estate market such as this because they expand the universe of potential buyers.

Typically, the additional monies paid by the lessees are not refundable if tenants fail to make the purchase.

But realize there could be serious complications to breaking a lease-option before the tenant's option term expires. If the renters/buyers had the foresight to file a Memorandum of Agreement with the county clerk, indicating the tenants have an interest in the property, it may place a cloud -- though not a lien -- on your home's title. Further down the line, a prospective buyer may see this notation and demand the matter be resolved before moving forward with a sale.

Some lease-option tenants will fight eviction and claim in court they have an "equitable interest" in the property. The more "equity" the tenant has amassed, the more likely it is a judge will rule the arrangement an equitable mortgage, forcing you to go the foreclosure route. In some cases, the IRS has identified lease-option payments as installment-sale payments and made the original owner pay tax and penalties on them.

You didn't say whether the renters/buyers have lived up to their end of the agreement. If the tenant has stopped paying rent but the total option money you received thus far exceeds 5 percent of the agreed-upon purchase price, you may indeed be required to go through the foreclosure process.

What's more, there are scammers out there operating under the tutelage of so-called real estate gurus whose sole intent is to evict lease-option tenants at the end of the lease period with no benefits whatsoever derived from the extra upfront money and rent premiums they paid. You don't want to get lumped into this category in court.

There may be additional local nuances governing the tenant-landlord relationship to which you've not been made privy. Hence, you'll probably need a real estate lawyer or other qualified professional to help you.

First, however, you may want to have a talk with your tenants about their intent to go forward with the purchase -- without tipping them off to your own plan to sell the place out from under them, of course.

Often, the cash-poor or damaged-credit position that tenants were in when they entered the lease-option has not improved a couple years later. In the end, in fact, fewer than a third of lessees in such deals are able to exercise their options. So it may be a moot point.

Bankrate.com's corrections policy -- Posted: June 29, 2008
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