Deborah Evans needed a house yesterday. Steve Aaron wanted to sell his house today, but was willing to wait till tomorrow. The solution: a lease-purchase agreement.
Evans agreed she would rent Aaron’s house in the city’s Feltonville section for 90 days and then buy it when the lease was up. It became hers on Aug. 31.
It was an arrangement that worked well for both sides. Evans, her two college-age daughters and her mother had been renting from a landlord who needed the home back for his family.
But Evans hadn’t even been considering homeownership and needed time to obtain a mortgage. Aaron’s house was close to her job, and fit her needs.
“It was an emergency move,” said Evans, who is the manager of senior citizen housing for a subsidiary of Tenth Memorial Baptist Church in Philadelphia. “We looked at other places, but none was as close to work as this one.”
Happy buyer, satisfied seller. Lease-purchase agreements-in which the buyer agrees to first lease the house for a specific time before purchasing it-are a tiny percentage of real estate sales, but they can provide a way for renters with credit problems or small personal savings to become homeowners.
Often, these arrangements are set up to help the home buyer save by applying a portion of the rent to the down payment.
Here’s how it works: A tenant is paying his landlord $550 a month rent, even though fair market value for rent in the neighborhood is $400 a month. In a lease-purchase arrangement, anything above fair market rent can be applied to the down payment. So the prospective buyer, after 12 months, has paid $1,800 that will be applied toward the purchase price.
These agreements provide a method for home buyers to find, and hold on to, the house of their dreams until they are able to afford it.
They can also solve a few problems for some sellers. Primarily, lease- purchase agreements are used by owners who are having difficulty selling their homes or by sellers located in stagnant housing markets. The agreement puts a renter into the house, and provides them with money to meet mortgage payments and expenses.
So, why aren’t lease-purchase agreements used more frequently?
“Frankly, it’s a pain for real estate agents,” said Al Breinig, a Montgomery County lawyer who has handled lease-purchase arrangements and whose builder-father helped pioneer the technique in Pennsylvania. “It’s time consuming and tedious, and requires them to deal with more legal provisions than in a straight sale.”
It also delays the agent’s commission, Breinig said, although “commission time is negotiable and can either be deferred or staggered to provide an incentive for the sales agent.”
Christopher Ryan, a broker-associate with Prudential Preferred Properties in the city’s Fairmount section, has used lease-purchase to acquire and renovate houses for resale. But, he cautions, “you need to educate both the buyer and the seller to make it a win-win situation.”
In negotiating lease-purchase, Ryan typically has had to get the seller and the buyer to compromise on three major points:
– How much of the rent will go toward the purchase price.
“The seller usually wants none of it; the buyer wants all of it,” Ryan said. “But the more rent money that’s committed, the less of a chance that the prospective buyer will walk away from the deal.”
There is one problem with applying rent to the down payment or the purchase price, according to Bernie Rubin, co-owner of Rubin Montgomery Realty in Center City, which has done a small number of lease-purchase arrangements over the last three years.
“The rent credit has to be escrowed so it can be verified by the mortgage lender,” Rubin said, “and very few landlord-sellers will do so. They need the rent money to meet expenses.”
Breinig, however, said the money does not have to be escrowed if a notarized copy of a formally executed lease-purchase arrangement is filed with the city or county clerk.
The security deposit in a lease-purchase agreement is usually three months’ rent, instead of the two months’ security usually required in a typical rental agreement. One month is usually applied to the down payment, if it meets fair-market rental rules required by the secondary mortgage market.
– Length of rental time.
“A buyer wants it long, a seller wants it to be short,” Ryan said. “Typically, though, it’s a year.”
– Price. Again, said Ryan, it’s an effort to reach a compromise on two opposing points of view.
Breinig strongly recommends that any lease-purchase agreement be recorded to protect both parties.
“Remember, the house still belongs to the owner,” Breinig said. “If the owner wants to refinance his mortgage on the house or take out liens against it, an unscrupulous or financially exhausted seller could borrow to the hilt against the house, then have the debt on it exceed the purchase price and the sale could not be closed.
“But all of this, including limits on the amount the seller can borrow up to his equity, can be specified in the agreement,” he said.
Sometimes, builders and developers use lease-purchase agreements to move inventory in slow markets. Breinig’s father, for example, had acquired properties all over Pennsylvania during the 1950s. Lease-purchase programs helped him to move houses quickly.
Arnold Galman, who converts apartment buildings to condos in Northeast Philadelphia and the suburbs, used lease-purchase to sell his condos for several years.
“It worked really well,” Galman said. “If you knew you’d be on a conversion job for a couple of years, it was a good way to move” inventory, he said.
It also offered the marginal buyer a chance at homeownership, he said. “This way, a person with not a lot of money and a good salary was able to save money for a down payment and own his own home,” Galman said.
Chuck Valentine, director of housing counseling services for the New Kensington Community Development Corp. in Philadelphia, thinks lease-purchase agreements can be a key to solving some of the housing problems in the metropolitan area.
“We have 20,000 vacant houses in the city that could have been occupied had the agents and owners agreed to lease-purchase,” said Valentine.
“It’s an actual tool that we could use if the supply side (the sellers) understood it,” he said. “We see 600 clients a year and secure only 100 to 150 mortgages. A lot of the rest get nervous and back off, or have credit problems that need to be repaired. If they could find a house they wanted and could live in it while they take care of their problems, it would provide the incentive they need.”
Lease-purchase agreements commonly are used to give low- and moderate- income buyers time to meet the myriad requirements for obtaining a mortgage.
“Credit repair usually takes about 10 months,” Valentine said. “If a person is faithful to it, he can get the bank to consider him for a mortgage at the end of the 10 months, and with a 12-month lease-purchase, has two months in which to get the mortgage.
